8 months for a total salary of $100,000 payable in monthly installments of $1,250. Teeples was to serve in an executive capacity with the corporation in matters relating to the management and administration of the corporation's overall construction activities, particularly with respect to matters involving the bidding, planning, negotiating, and supervision of contracts relating to construction jobs.

During the period March 1, 1963, to August 1, 1963, Teeples rendered services for the corporation, such as visiting prospective clients, negotiating jobs, and setting up contracts.

In June 1963, Teeples received a mission call from his church, the Church of Jesus Christ of Latter Day Saints, which he duly accepted, to serve as an adviser to the church in Formosa for construction activities it carried on there. Sometime in August 1963, Teeples left the United States to travel to Formosa to serve his mission and did not return to this country for approximately 3 years.

On July 22, 1963, a special joint meeting of the stockholders and directors of the corporation was held because of the mission call Teeples had received. At this meeting, it was decided that the corporation would continue to make payments to Teeples pursuant to the employment agreement of March 1963. During the period Teeples was in Formosa, the corporation continued to make the monthly payments to him specified in the agreement of March 1963. No services were actually rendered by Teeples to the corporation during the period he was in Formosa.

During the taxable period February 1, 1963, to December 31, 1963, and the year 1964, the corporation made total payments of $14,700 and $15,000, respectively, to Teeples and claimed deductions for these amounts in computing its taxable income. The respondent has disallowed $5,950 of the amount claimed for the period from February 1 to December 31, 1963, and $12,000 of the amount claimed for the year 1964.

OPINION

First, we must decide the principal issue of whether the liabilities transferred to, and assumed by, the corporation in a section 351 exchange exceeded the adjusted basis of the assets transferred to the corporation.

Section 351(a) provides that where property is transferred to a corporation solely in exchange for stock or securities of such corporation, and immediately after the exchange the transferor is in control of the corporation, no gain or loss shall be recognized on the exchange. However, section 357 (c) (1) provides that in a section 351 exchangeif the sum of the amount of the liabilities assumed, plus the amount of the liabilities to which the property is subject, exceeds the total of the adjusted basis

of the property transferred pursuant to such exchange, then such excess shall be considered as a gain from the sale or exchange of a capital asset or of property which is not a capital asset, as the case may be.

The parties agree that the liabilities assumed by the corporation, excluding accounts payable, amounted to $264,194.52, and that the total adjusted basis of the assets transferred, other than accounts receivable, was $325,892.33. They disagree on the treatment to be accorded the accounts receivable and accounts payable. The respondent contends that the adjusted basis of the accounts receivable was zero, that the accounts payable of $164,065.54 were liabilities, and that, therefore, the amount of the liabilities assumed, $428,260.06, exceeded the total adjusted basis of the assets transferred, $325,892.33, by $102,367.73. On the other hand, the petitioners contend that the adjusted basis of the accounts receivable is equal to the amount of the accounts payable, $164,065.54, and that, therefore, the amount of the liabilities assumed, $428,260.06, did not exceed the total adjusted basis of the assets transferred, $489,957.78. Alternatively, they contend that accounts payable of a cash basis taxpayer are not liabilities within the meaning of section 357 (c), and that, therefore, even if the accounts receivable had a zero basis, the amount of liabilities assumed within the meaning of section 357 (c), $264,194.52, did not exceed the total adjusted basis of the assets transferred, $325,892.33.

In Peter Raich, 46 T.C. 604 (1966), the assets of a sole proprietorship, including accounts receivable, were transferred to a corporation in a section 351 transaction, and the corporation assumed the liabilities, including the accounts payable, of the sole proprietorship. The issue was the same as in this case, and this Court concluded that the basis of a cash method taxpayer in accounts receivable was zero, treated the accounts payable as liabilities, and found that the liabilities assumed by the corporation exceeded the basis of the assets transferred.

The petitioners take the position that the Raich case is distinguishable because that case involved a transfer of assets by a sole proprietor, whereas the present case involves a transfer of assets by a partnership. They argued at great length that section 751 and the regulations thereunder provide a different basis for the accounts receivable of a partnership. Section 751 (c) provides that for the purposes of subchapter K, the term "unrealized receivables" includes accounts receivable "to the extent not previously includible in income under the method of accounting used by the partnership." Section 1.751–1 (c) (2) of the Income Tax Regulations provides:

(2) The basis for such unrealized receivables shall include all costs or expenses attributable thereto paid or accrued but not previously taken into account under the partnership method of accounting.

The petitioners interpret such regulation to mean that, for all purposes throughout the Code, the accounts receivable of a partnership reporting its income on the cash receipts and disbursements method of accounting have a basis equal to the accounts payable attributable to such accounts receivable. They, therefore, conclude that their accounts receivable had a basis of $164,065.54.

The petitioners' argument overlooks the fact that section 751 has an altogether different purpose. That section has been referred to as the "collapsible" partnership provision. See, e.g., S. Rept. No. 1616, 86th Cong., 2d Sess., p. 77 (1960); S. Rept. No. 1622, 83d Cong., 2d Sess., p. 98 (1954); Willis, Partnership Taxation, sec. 20.08 (1971). It was enacted in response to cases such as Swiren v. Commissioner, 183 F.2d 656 (C.A. 7, 1950), reversing a Memorandum Opinion of this Court, certiorari denied 340 U.S. 912 (1951). In Swiren, the taxpayer sold his partnership interest in a law firm, whose assets consisted largely of uncollected or unbilled legal fees, and the Court held that the entire gain from such sale was capital gain, even though the receipt of the legal fees by the partnership would have given rise to ordinary income. Section 751 (a) seeks to prevent such a "conversion of potential ordinary income into capital gain" (S. Rept. No. 1622, supra at p. 98), and it provides that:

(a) SALE OR EXCHANGE OF INTEREST IN PARTNERSHIP.-The amount of any money, or the fair market value of any property, received by a transferor partner in exchange for all or a part of his interest in the partnership attributable to— (1) unrealized receivables of the partnership, or

(2) inventory items of the partnership which have appreciated substantially in value,

shall be considered as an amount realized from the sale or exchange of property other than a capital asset.

To assure that the rules of section 751 with respect to the transfer of partnership interests are not avoided by distributions of property to a partner, other sections of subchapter K provide special rules for the treatment of "section 751 property," including unrealized receivables, which is distributed to a partner. Secs. 731, 732, 735, 736, 741.

The regulations under section 751 are designed to provide a method of determining how much of the sale price of a partnership interest should be allocated to the "property other than a capital asset" and the amount of gain or loss which should be attributable to the transfer of such property. Thus, such regulations provide rules for measuring the amount of ordinary income to be recognized on the sale of a partnership interest. Such rules are also applicable under the other provisions of subchapter K relating to the distribution of section 751 property to a partner. It should be emphasized that the regulations under section 751 are designed to measure income, and not to establish gen

eral basis rules. Similarly, in Herman Glazer, 44 T.C. 541, 546 (1965), this Court was required to determine whether the proceeds of the sale of a partnership interest should be treated as ordinary income, and its statement (p. 549) concerning basis related only to the determination of the proper amount of such income.

On the contrary, section 357 deals with the tax consequences of the transfer of liabilities to a corporation in a transaction subject to section 351. In United States v. Hendler, 303 U.S. 564 (1938), it was held that if a corporation assumed a liability of the transferor, it was as if the corporation had made the payment to the transferor. The predecessor of section 357 (a) was enacted to change the rule established by Hendler; thus, liabilities could be transferred to a corporation in a transaction under section 351 without the transferor being taxed thereon. However, when that rule was enacted, Congress also enacted the limitation now appearing in section 357 (b); that is, if the principal purpose of the transfer of the liabilities was to avoid tax or was not a bona fide business purpose, the rule of section 357 (a) was not applicable. Yet, Congress was apparently not satisfied with the results of the limitation set forth in section 357 (b), and consequently, in 1954, it enacted the rule of section 357 (c). That provision established a mechanical test; whenever the liabilities transferred exceed the basis of the property transferred, the excess is taxable. The provision is applicable irrespective of the value of the property transferred or of whether the transferor realized a gain or income on the transfer. Thus, in view of the altogether different purposes of sections 751 and 357 (c), there is no reason to extend to a transaction under section 357 (c) the rules developed under section 751.

Moreover, if we were to adopt the petitioners' argument that section 751 and the regulations thereunder are applicable when a partnership transfers its assets and liabilities to a corporation, such a transfer by a partnership would have different tax consequences than a similar transfer by a proprietor. See Peter Raich, 46 T.C. 604 (1966). Such a difference in tax treatment would be irrational, and its irrationality constitutes a persuasive reason for not reaching such a result. Nor is there any merit in the petitioners' reliance on section 771, for that section merely establishes the effective dates of the provisions of subchapter K; it does not define what transactions are subject to section 751. Because we have found that the regulations under section 751 are not applicable in this case, we need not decide whether the petitioners' interpretation of the wording of section 1.751-1 (c) (2) is correct.

The petitioners also challenge our holding in Raich that accounts receivable have a zero basis in the hands of a taxpayer using the cash method of accounting. However, in the case of a taxpayer using that

method of accounting, it is generally accepted that the accounts receivable do have a zero basis. Peter Raich, supra at 610-611; see 3 Mertens, Law of Federal Income Taxation, sec. 20.159 fn. 9 (1972); 3 Rabkin & Johnson, Federal Income, Gift and Estate Taxation, sec. 31.05 (1973); White, "Sleepers that Travel with Section 351 Transfers," 56 Va. L. Rev. 37, 41 (1970); cf. Velma W. Alderman, 55 T.C. 662 (1971). Since the accounts payable represent expenses not yet paid, there is no reason to allow a deduction or otherwise take them into consideration in computing the income of a cash method taxpayer prior to their payment. See sec. 1.461-1(a)(1), Income Tax Regs. Furthermore, the accounts receivable should be included in income when collected, and although the petitioners suggest that the basis of the receivables could be computed as if they had been acquired by purchase, there is no authority for such a proposition. Accordingly, we hold that the accounts receivable transferred by the petitioners to the corporation had a zero basis.

In the alternative, the petitioners point to the decision of the Second Circuit in Bongiovanni v. Commissioner, 470 F. 2d 921 (1972), reversing a Memorandum Opinion of this Court, and urge us to hold that accounts payable should not be treated as liabilities within the meaning of section 357 (c). In Bongiovanni, the circuit court believed that if accounts receivable and accounts payable are transferred to a corporation, it would frustrate the purpose of section 351 to hold that the transferor was taxable on the accounts payable under section 357 (c); accordingly, the court held (p. 924) that liabilities under section 357 (c) meant "liens in excess of tax costs, particularly mortgages encumbering property transferred in a Section 351 transaction." The petitioners appear to recognize that the Bongiovanni interpretation of liabilities is too narrow, but they suggest that the term should be construed to include only mortgages and other "capital loans."

The circuit court's holding in Bongiovanni cannot be reconciled with the language of section 357 (c); such provision is applicable when "the sum of the amount of the liabilities assumed, plus the amount of the liabilities to which the property is subject" exceeds the basis of the property transferred. If the term "liabilities" was limited to liens, there would be no need to refer, in section 357 (c), to liabilities which are assumed as separate from those to which the transferred property is subject. Moreover, in N.F. Testor, 40 T.C. 273 (1963), affd. 327 F. 2d 788 (C.A. 7, 1964), this Court and the Seventh Circuit both specifically held that section 357 (c) applied to a situation in which the only liabilities transferred were unsecured liabilities.

The Senate Finance Committee report, accompanying the enactment of section 357 (c), stated: