ORINION
Milling, a qualifying subchapter S corporation, had undistributed taxable income for years prior to its taxable year ended February 28, 1963, which had been previously taxed to its shareholders. On the last day of such taxable year it initiated certain steps in an attempt to distribute to its shareholders substantially all of such previously taxed income. On February 28, 1963, it issued checks in the amount of $345,000 to them. On March 1,1963, they issued their checks to Milling in the amount of $117,500 and received debentures and short-term notes from Milling in that amount. A similar procedure was followed around the end of Milling’s taxable year ended February 29, 1964, although at such time Milling did not attempt to effect any distribution of previously taxed income. On February 29,1964, Milling issued checks to its shareholders in the total amount of $165,745. On or about March 1, 1964, they issued their checks to Milling in the total amount of $69,505 and received debentures and short-term notes from Milling in that amount.
The basic question presented for our decision is whether Milling’s issuance of checks on February 28, 1963, and February 29, 1964, constituted in full money distributions at those times or whether, as determined by the respondent, the above transactions constituted in substance money distributions only to the extent of $227,500 and $96,240, respectively, and property distributions of $117,500 on March 1,1963, and $69,505 on March 1,1964.
At the outset it is helpful to outline the statutory and regulatory framework in which the present controversy arises.
Subchapter S was added to the Internal Revenue Code of 1954 by the Technical Amendments Act of 1958.6 Under section 1373 of the Code,7 the shareholders of ail electing subchapter S corporation are required to include in their income the amount they would have received as dividends if the corporation’s undistributed taxable income had been distributed pro rata to them on the last day of the corporation’s taxable year. During the years before us an electing corporation’s undistributed taxable income for any year consisted of its taxable income, computed without regard to certain deductions, less the amount of money distributed during such year as dividends within the meaning of section 316 (a) (2) of the Code.8 Thus, the shareholders of an electing subchapter S corporation are required to include in their income their prorata shares of the corporation’s taxable income to the extent of the corporation’s current earnings and profits regardless of whether such income is distributed to them in money or retained by the corporation. And, under sections 312 and 1377 of the Code9 the corporation’s current earnings and profits are correspondingly reduced by the amounts of money distributed to its shareholders and by the amounts included by them as constructively received.
Under section 1375(d) of the Code,10 an electing corporation may distribute to any shareholder such shareholder’s not share of the corporation’s undistributed taxable income which has been included in his income in prior taxable years. Such a distribution is not treated as a dividend and the earnings and profits of the corporation are not reduced thereby.
Under various sections of the Income Tax Regulations promulgated with respect to the provisions of subchapter S, the respondent has adopted tihe position that distributions of property other than money by an electing corporation are to be governed by principles applicable to corporate distributions in general. Thus, sections 1.1372-1 (c) (2) and 1.1372-1 (c) (7) of the regulations11 provide that property distributions are to be governed by section 301 and section 316 of the Code. Section 1.1373-1 of the regulations 12 provides that an electing corporation’s current earnings and profits shall first be allocated to actual distributions of money and that any remaining earnings and profits shall then be allocated ratably between actual distributions of property and the constructive distribution of undistributed taxable income. Under section 1.1375-4 of the regulations13 distributions of property other than money do not qualify as distributions of undistributed taxable income which has been previously taxed to the shareholders. Such section provides that distributions of previously taxed income may occur only when, and to the extent that, an electing corporation makes money distributions in excess of its current earnings and profits.
Under the above sections of the Code and the regulations it becomes evident that: (1) Because an electing corporation’s taxable income is reduced only by money distributions, in order to avoid having undistributed taxable income such corporation must currently distribute its taxable income in money; (2) once a corporation has undistributed taxable income wiiich has been previously taxed to its shareholders such income may be distributed to them without dividend treatment only if, and to the extent that, the corporation makes money distributions in excess of its current taxable income; and (3) distributions of property other than money are taxable as dividends, first to the extent of their ratable share of the corporation’s current earnings and profits, and then to the extent of such corporation’s accumulated earnings and profits.
The petitioners have not raised any issue as to the validity of the respondent’s regulations and we accordingly express no opinion with regard thereto. Cf. DeTreville v. United States, (D.S.C.) 312 F. Supp. 362, on appeal (C.A. 4). Bather, it is petitioners’ position that the issuance by Milling of checks in the amounts of $345,000 on February 28, 1963, and $165,745 on February 29, 1964, constituted, in substance as well as in form, money distributions at those times; that the distribution on February 28, 1963, met the requirements of section 1.1375-4 of the respondent’s regulations; and that, therefore, the amount distributed on February 28, 1963, in excess of Milling’s taxable income for its taxable year ended on that date constituted a nondividend distribution of previously taxed income.
It is the respondent’s position that the substance of the transactions involved must prevail over their form for tax purposes; that in substance Milling’s issuance of checks on February 28, 1963, and February 29, 1964, in the respective amounts of $345,000 and $165,745 constituted distributions of money at those times only to the extent of $227,500 and $96,240, respectively, and that this was followed by distributions of property consisting of notes and debentures on March 1, 1963, and March 1, 1964, in the respective amounts of $117,500 and $69,505; and that, therefore, a portion of Milling’s earnings and profits for its taxable year ended February 29, 1964, is properly allocable to the property distributed to petitioners on March 1, 1963, with the result that to such extent the petitioners received taxable dividends from Milling during their taxable years 1963.14
We agree with the respondent that the economic substance of a transaction must govern for tax purposes rather than the time sequence or form in which such transaction is cast. Gregory v. Helvering, 293 U.S. 465.
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ORINION
Milling, a qualifying subchapter S corporation, had undistributed taxable income for years prior to its taxable year ended February 28, 1963, which had been previously taxed to its shareholders. On the last day of such taxable year it initiated certain steps in an attempt to distribute to its shareholders substantially all of such previously taxed income. On February 28, 1963, it issued checks in the amount of $345,000 to them. On March 1,1963, they issued their checks to Milling in the amount of $117,500 and received debentures and short-term notes from Milling in that amount. A similar procedure was followed around the end of Milling’s taxable year ended February 29, 1964, although at such time Milling did not attempt to effect any distribution of previously taxed income. On February 29,1964, Milling issued checks to its shareholders in the total amount of $165,745. On or about March 1, 1964, they issued their checks to Milling in the total amount of $69,505 and received debentures and short-term notes from Milling in that amount.
The basic question presented for our decision is whether Milling’s issuance of checks on February 28, 1963, and February 29, 1964, constituted in full money distributions at those times or whether, as determined by the respondent, the above transactions constituted in substance money distributions only to the extent of $227,500 and $96,240, respectively, and property distributions of $117,500 on March 1,1963, and $69,505 on March 1,1964.
At the outset it is helpful to outline the statutory and regulatory framework in which the present controversy arises.
Subchapter S was added to the Internal Revenue Code of 1954 by the Technical Amendments Act of 1958.6 Under section 1373 of the Code,7 the shareholders of ail electing subchapter S corporation are required to include in their income the amount they would have received as dividends if the corporation’s undistributed taxable income had been distributed pro rata to them on the last day of the corporation’s taxable year. During the years before us an electing corporation’s undistributed taxable income for any year consisted of its taxable income, computed without regard to certain deductions, less the amount of money distributed during such year as dividends within the meaning of section 316 (a) (2) of the Code.8 Thus, the shareholders of an electing subchapter S corporation are required to include in their income their prorata shares of the corporation’s taxable income to the extent of the corporation’s current earnings and profits regardless of whether such income is distributed to them in money or retained by the corporation. And, under sections 312 and 1377 of the Code9 the corporation’s current earnings and profits are correspondingly reduced by the amounts of money distributed to its shareholders and by the amounts included by them as constructively received.
Under section 1375(d) of the Code,10 an electing corporation may distribute to any shareholder such shareholder’s not share of the corporation’s undistributed taxable income which has been included in his income in prior taxable years. Such a distribution is not treated as a dividend and the earnings and profits of the corporation are not reduced thereby.
Under various sections of the Income Tax Regulations promulgated with respect to the provisions of subchapter S, the respondent has adopted tihe position that distributions of property other than money by an electing corporation are to be governed by principles applicable to corporate distributions in general. Thus, sections 1.1372-1 (c) (2) and 1.1372-1 (c) (7) of the regulations11 provide that property distributions are to be governed by section 301 and section 316 of the Code. Section 1.1373-1 of the regulations 12 provides that an electing corporation’s current earnings and profits shall first be allocated to actual distributions of money and that any remaining earnings and profits shall then be allocated ratably between actual distributions of property and the constructive distribution of undistributed taxable income. Under section 1.1375-4 of the regulations13 distributions of property other than money do not qualify as distributions of undistributed taxable income which has been previously taxed to the shareholders. Such section provides that distributions of previously taxed income may occur only when, and to the extent that, an electing corporation makes money distributions in excess of its current earnings and profits.
Under the above sections of the Code and the regulations it becomes evident that: (1) Because an electing corporation’s taxable income is reduced only by money distributions, in order to avoid having undistributed taxable income such corporation must currently distribute its taxable income in money; (2) once a corporation has undistributed taxable income wiiich has been previously taxed to its shareholders such income may be distributed to them without dividend treatment only if, and to the extent that, the corporation makes money distributions in excess of its current taxable income; and (3) distributions of property other than money are taxable as dividends, first to the extent of their ratable share of the corporation’s current earnings and profits, and then to the extent of such corporation’s accumulated earnings and profits.
The petitioners have not raised any issue as to the validity of the respondent’s regulations and we accordingly express no opinion with regard thereto. Cf. DeTreville v. United States, (D.S.C.) 312 F. Supp. 362, on appeal (C.A. 4). Bather, it is petitioners’ position that the issuance by Milling of checks in the amounts of $345,000 on February 28, 1963, and $165,745 on February 29, 1964, constituted, in substance as well as in form, money distributions at those times; that the distribution on February 28, 1963, met the requirements of section 1.1375-4 of the respondent’s regulations; and that, therefore, the amount distributed on February 28, 1963, in excess of Milling’s taxable income for its taxable year ended on that date constituted a nondividend distribution of previously taxed income.
It is the respondent’s position that the substance of the transactions involved must prevail over their form for tax purposes; that in substance Milling’s issuance of checks on February 28, 1963, and February 29, 1964, in the respective amounts of $345,000 and $165,745 constituted distributions of money at those times only to the extent of $227,500 and $96,240, respectively, and that this was followed by distributions of property consisting of notes and debentures on March 1, 1963, and March 1, 1964, in the respective amounts of $117,500 and $69,505; and that, therefore, a portion of Milling’s earnings and profits for its taxable year ended February 29, 1964, is properly allocable to the property distributed to petitioners on March 1, 1963, with the result that to such extent the petitioners received taxable dividends from Milling during their taxable years 1963.14
We agree with the respondent that the economic substance of a transaction must govern for tax purposes rather than the time sequence or form in which such transaction is cast. Gregory v. Helvering, 293 U.S. 465. And it is well established that where a series of closely-related steps are taken pursuant to a plan to achieve an intended result the transaction must be viewed as an integrated whole for tax purposes. Redwing Carriers, Inc. v. Tomlinson, (C.A. 5) 399 F. 2d 652, and oases cited therein.
At the trial the petitioners adduced testimony to the effect that Milling did not know the extent to which its shareholders would make loans to it at the time its distributions were made, that such loans were voluntarily made by the shareholders, and that the loans were made by the shareholders because the notes and debentures represented sound investments. Be this as it may, the record as a whole convinces us that the purported loans by the shareholders were made pursuant to a general understanding between Milling and its shareholders. The conversations which were had between Milling’s president or comptroller and the shareholders with respect to the purported loans, the degree of correspondence between the book overdrafts created by Milling’s distributions and the amounts purportedly loaned back by its shareholders, the close proximity in time of the purported loans and the issuance of checks by Milling, and the correlation between the amounts purportedly loaned by each shareholder and his interest in Milling, all serve to establish that tire purported distributions and loans were but parts of interrelated transactions which must be viewed as such for tax purposes.
Our view of the substance of the transactions in question, however, differs somewhat from that urged by the respondent. In our opinion, the distributions by Milling on February 28, 1963, and February 29, 1964, constituted, hr substance, distributions on such dates of cash in the respective amounts of $227,500 and $96,240 and property consisting of notes and debentures in the respective amounts of $117,500 and $69,505, It is true, of course, that the notes and debentures were not formally issued by Milling until the dates following the dates upon which its checks were issued. However, it is clear that some portion of each check was issued pursuant to an understanding that notes and debentures would be substituted therefor. Under the circumstances, in substance, the notes and debentures were issued on February 28,1963, and February 29, 1964. Once an integrated transaction is to be viewed as such for tax purposes, its component parts do not admit of separation. Redwing Carriers v. Tomlinson, supra, and cases cited therein.
In view of the above, it is our conclusion that the notes and debentures received by petitioners dated March 1, 1963, did not constitute nondividend distributions of undistributed but previously taxed income. Such notes and debentures are taxable to them in their taxable years 1963 but only to the extent oí a ratable portion of Milling’s earnings and profits for its taxable year ended February 28, 1963, rather than a ratable portion of Milling’s earnings and profits for its taxable year ended February 29, 1964, as determined by the respondent. The notes and debentures received by petitioner Roesel dated March 1,1964, are taxable to her in her taxable year 1964 to the extent of a ratable portion of Milling’s earnings and profits for its taxable year ended February 29,1964. To the extent that the notes and debentures received by petitioners are not deemed to be out of Milling’s earnings and profits, the basis of petitioners’ respective stock in Milling will be reduced pursuant to the provisions of section 301 of the Code.
Decisions will be entered under Bule 50.