if an individual transfers, under section 351, property having a basis in his hands of $20,000, but subject to a mortgage of $50,000, to a corporation controlled by him, such individual will be subject to tax with respect to $30,000, the excess of the amount of the liability over the adjusted basis of the property in the hands of the transferor. [S. Rept. No. 1622, 83d Cong., 2d Sess., p. 270 (1954).]

Thus, the operation of the rule is illustrated by a situation involving a secured liability. However, there is no other indication in the legislative history that the term liabilities should be confined to secured liabilities. Furthermore, there is no reason to believe that Congress intended for the rule not to apply if the transferor secured funds by means of an unsecured loan and transferred both the assets and that obligation to a new corporation. Nor is there any reason to believe that section 357 (c) was intended never to apply to a transfer of accounts payable. For example, if a proprietor transfers accounts payable in excess of accounts receivable and no other assets, he is relieved of the necessity of paying off the excess of liabilities, and Congress may have intended for section 357 (c) to apply in such a situation.

We recognize that if section 357 (c) is applied when a proprietor or partnership transfers to a corporation a going business, including accounts receivable, accounts payable, and other assets, it may appear to undermine the purpose of section 351. Yet, there is no support for adopting the definition suggested by the petitioners, and we can find no rational basis for giving the term "liabilities" a restrictive meaning. Under these circumstances, we must assume that Congress intended for the term "liabilities" to have its ordinary meaning. United States v. Stewart, 311 U.S. 60 (1940).

Nor can we remake the transaction for the parties. Weiss v. Stearn, 265 U.S. 242, 254 (1924); Paula Construction Co., 58 T.C. 1055 (1972), affirmed per curiam 474 F. 2d 1345 (C.A. 5, 1973). If the partnership had withheld accounts payable and an equivalent amount of the accounts receivable, the tax consequences would have been altogether different. However, the accounts payable and the accounts receivable were all transferred to the corporation, and since the corporation has collected the accounts receivable and paid the accounts payable, we cannot ignore such facts and determine the tax consequences for the corporation as if such transfer had not taken place. Thus, we hold that the accounts payable transferred by the petitioners to the corporation must be treated as liabilities under section 357 (c). The resolution of the problem illustrated by this case will require Congress and the Administration to reconsider the mechanical test adopted in 1954 and to decide what rule should be applied to a transfer of liabilities; it will then be necessary for them to take appropriate legislative or administrative action.

The petitioners finally contend that the issue of whether income was recognized on the transfer of assets to the corporation is not before us, because such issue was conceded by the respondent in his answer. We do not interpret the answer as having conceded such issue. Moreover, in his opening statement, counsel for the petitioners referred to such issue as the "essential" issue of the trial, and at trial, the petitioners presented evidence on such issue. In their briefs, the parties have extensively argued the issue. Under such circumstance, it is clear that the issue is properly before us. See, e.g., Ross Glove Co., 60 T.C. 569 (1973); Nat Harrison Associates, Inc., 42 T.C. 601, 617-618 (1964). In view of our holding as to the applicability of section 357(c), the partnership's adjusted basis in the stock which it received from the corporation in exchange for the transfer of assets was zero. Pursuant to section 358, the basis of the stock so acquired is computed by increasing the partnership's adjusted basis in the transferred assets ($325,892.33) by the gain recognized on the transfer ($102,367.73) and by reducing such total by the amount of the liabilities assumed by the corporation and those to which the transferred property was subject ($428,260.06).

It remains for decision whether respondent erroneously determined that not more than $250 of a total of $1,250 per month paid by the corporation to Teeples during his absence in Formosa was allowable as an ordinary and necessary expense under section 162 (a) (1)."

Briefly, the facts are that Teeples and the corporation entered into a contract whereby in consideration of specified services, the corporation would pay Teeples $1,250 per month. Thereafter, in accordance with the custom of his church (Church of Jesus Christ of Latter Day Saints), Teeples was called upon to undertake a mission for the church in Formosa. He accepted the call. Thereupon the board of directors of the corporation voted to continue his salary during his absence. The respondent has determined that at least to the extent of $1,000 per month, the amounts paid to Teeples were not an allowable deduction under section 162 (a) (1).

The petitioner has the burden of proof that the amount in question constituted reasonable compensation within the meaning of section 162 (a) (1). Petitioner failed to do so. Teeples performed no services

Since the decision in this issue turns on the evaluation of the evidence in the case, we have adopted Judge Quealy's opinion with respect to it.

SEC. 162. TRADE OR BUSINESS EXPENSES.

(a) IN GENERAL.-There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including

(1) a reasonable allowance for salaries or other compensation for personal services actually rendered;

for the corporation while in Formosa. With respect to what services he may have performed prior to leaving, the testimony was vague and general, if not contradictory. The corporation was under no obligation to Teeples and the fact that the corporation elected to continue his salary, although commendable, did not give rise to an allowable deduction.

In accordance with the foregoing,

Reviewed by the Court.

Decisions will be entered under Rule 50.

QUEALY, J., dissenting and concurring: I must disagree with the opinion of the majority with respect to the application of section 357 (c) to the facts in this case.

With respect to this issue, the opinion of the majority follows the line of prior decisions of this Court in N. F. Testor, 40 T.C. 273 (1963), affd. 327 F.2d 788 (C.A. 7, 1964), and Peter Raich, 46 T.C. 604 (1966). That view was rejected by the U.S. Court of Appeals for the Second Circuit in Bongiovanni v. Commissioner, 470 F. 2d 921 (C.A. 2, 1972), reversing T.C. Memo. 1971-262. While it was my decision that was reversed, I am in full accord with the decision of the appellate court in the Bongiovanni case.

There are inherent problems in applying section 357 (c) in the case of a taxpayer whose books and records are kept on the cash basis of accounting where there has been a transfer of the business in "midstream." Since neither all of the income actually earned nor all of the expenses actually incurred may be reflected on the books of such taxpayer, the transferor will not have fully accounted for its income and deductions. Where the transfer qualifies for nonrecognition under section 351, the transferee is required to pick up any unreported income and receives the benefit of any deductions attributable thereto which have not been paid by the transferor. Under the opinion of the majority, however, the allowance of the deduction to the transferee is offset by the inclusion of a corresponding amount in the gain taxable to the transferor under section 357 (c). This has troubled the courts. Bongiovanni v. Commissioner, supra; Peter Raich, supra.1

As was aptly pointed out by the appellate court in Bongiovanni v. Commissioner, supra, section 351 was originally enacted to provide for the simple incorporation of a sole proprietorship or partnership for purposes of continuing the business in that form without the realization of any taxable gain or loss. Where the liabilities assumed in that type of transaction are reflected in the transferor's method of account

1A similar harsh result may follow where a cash basis taxpayer becomes bankrupt. Henry C. Mueller, 60 T.C. 36 (1973).

ing, it is only logical to take such liabilities into account in determining the consideration received.2

On the other hand, where neither the liabilities in question nor the corresponding receivables have been taken into account under the taxpayer's method of accounting, the treatment of such liabilities as "other property” received by the transferor produces an absurd result. Accordingly, in the Bongiovanni case, the appellate court said:

Section 357 (c)—if read literally-requires that "liabilities" assumed by the transferee corporation which exceed the aggregate adjusted basis of the properties transferred are to be considered as gain from the sale or exchange of that property. However, we believe that the word "liability” is used in Section 357 (c) in the same sense as the word "liability" referred to in the legislative history of Section 357 (c). It was not meant to be synonymous with the strictly accounting liabilities involved in the case at bar. Section 357 (c) was meant to apply to what might be called "tax" liabilities, i. e., liens in excess of tax costs, particularly mortgages encumbering property transferred in a Section 351 transaction. See 3 U.S. Code Cong. & Admin. News pp. 4064, 4266-67, 4908 (1954). Any other construction results in an absurdity in the case of a cash basis taxpayer whose trade accounts payable are not recognized as a deduction (because he is on the cash basis) but whose "liabilities" (although unpaid) are recognized for purposes of Section 357 (c). The payables of a cash basis taxpayer are "liabilities" for accounting purposes but should not be considered "liabilities" for tax purposes under Section 357 (c) until they are paid. See Note, Section 357 (c), And The Cash Basis Taxpayer, 115 U. Pa. L. Rev. 1154 (1967). [470 F. 2d 921, 923–924 (C.A. 2, 1972).1

In resolving this issue, wherever possible it is our duty to arrive at a decision which will be compatible with the statute as a whole. As Judge Rives said in Davant v. Commissioner, 366 F. 2d 874, 879 (C.A. 5, 1966), "rules prescribed by Congress in the Code are often wholly reasonable and appropriate when taken in isolation, but that fact alone should not and must not prevent a court from harmonizing these apparently divergent elements of specific policy so that they may continue to cohabit the same body of general law which Congress has directed shall be viewed as a single plan."

The decision of the appellate court in the Bongiovanni case achieves that result. In fact, it more nearly carries out the intent of the Congress in that a distinction is made not on the basis of "secured liabilities," but on the basis whether the liability in question was reflected in determining the income and expense of the taxpayer on a cash basis. Where a taxpayer buys a depreciable asset with borrowed funds, the deduction for depreciation enters into the computation of the taxpayer's income on a cash basis of accounting regardless whether the borrowings constitute a lien on the asset or represent a general obliga

For example, where the transferor has purchased machinery and equipment with borrowed funds, irrespective of the method of accounting, the transferor's basis for depreclation reflected the full cost of the machinery and equipment.

tion of the taxpayer. The indebtedness is reflected in the taxpayer's accounting. On the other hand, where the liability represents an inventoriable or deductible expense, it cannot be reflected in the computation of income on a cash basis until paid. The distinction makes sense, and I would adopt it.

With respect to the second issue, the facts are that for some 7 years Mr. Thatcher and Mr. Teeples had been partners in the contracting business in Portland, Oreg., and in the operation of a farm some 350 miles distant. They divided their duties, Mr. Thatcher being in charge of the contracting business and Mr. Teeples being in charge of the farm. As of January 1, 1963, a corporation was organized to take over the contracting business. Mr. Teeples owned or controlled 300 shares of a total of 500 shares of stock outstanding. In March 1963, the corporation entered into a contract to pay Mr. Teeples a total of $100,000 in monthly installments of $1,250 for such services as he might perform for the corporation. It was understood at that time that Mr. Teeples would continue to reside at the farm but would be available. from time to time as needed.

In May of 1963, the corporation redeemed or repurchased the 300 shares of stock owned by Mr. Teeples for the sum of $42,500. Thereafter, in accordance with the custom of his church (Church of Jesus Christ of Latter Day Saints), Mr. Teeples was called upon to undertake a mission for the church in Formosa. He accepted the call. Thereupon the board of directors of the corporation voted to continue his salary during his absence. The respondent has determined that at least to the extent of $1,000 per month, the amounts paid to Mr. Teeples were not an allowable deduction under section 162 (a) (1).

It is clear from the record that Mr. Teeples was withdrawing from the contracting business, whether in anticipation of the call from his church or otherwise. He so testified. Furthermore, in determining the price at which his stock, representing three-fifths of the outstanding stock of the corporation, was redeemed, Mr. Teeples said:

I did not have access to the books, but I have an accountant that was handling the books all of the time. And when this split came we, of course, figured what we had, less the liabilities and the obligations that I had, to complete the jobs that we would have to complete, and that was the amount of money that was left over.

Such testimony is only compatible with the facts if it is assumed that the contractual liability to pay Mr. Teeples $1,250 per month until October 30, 1969, was also taken into account. In other words, either the employment contract was a part of the consideration for the sale by Mr. Teeples of his stock or the financial condition of the corporation was grossly understated to him. Since he was the controlling stock

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