COMMISSIONER OF INTERNAL REVENUE, PETITIONER V. DONALD E. CLARK AND
PEGGY S. CLARK

   No. 87-1168

   In the Supreme Court of the United States

   October Term, 1987

   The Solicitor General, on behalf of the Commissioner of Internal
Revenue, petitions for a writ of certiorari to review the judgment of
the United States Court of Appeals for the Fourth Circuit in this
case.

   Petition for a Writ of Certiorari to the United States Court of
Appeals for the Fourth Circuit

            TABLE OF CONTENTS
   Questions Presented
   Opinions below
   Jurisdiction
   Statute involved
   Statement
   Reasons for granting the petition
   Conclusion

                            OPINIONS BELOW

   The opinion of the court of appeals (App., infra, 1a-14a) is
reported at 828 F.2d 221.  The opinion of the Tax Court (App., infra,
15a-39a) is reported at 86 T.C. 138.

                             JURISDICTION

   The judgment of the court of appeals (App., infra, 40a) was entered
on September 4, 1987.  On November 24, 1987, the Chief Justice
extended the time for filing a petition for a writ of certiorari to
and including January 2, 1988.  On December 17, 1987, the Chief
Justice further extended the time for filing a petition for a writ of
certiorari to and including January 11, 1988.  The jurisdiction of
this Court is invoked under 28 U.S.C. 1254(1).

                           STATUTE INVOLVED

   The relevant portions of Section 302, 316, 317, 354, and 356 of the
Internal Revenue Code (26 U.S.C.) are set forth in a statutory
appendix (App., infra, 41a-45a).

                          QUESTION PRESENTED

   In this case, a relatively small corporation was merged into a
subsidiary of a large publicly-owned corporation, and the sole
shareholder of the acquired corporation received in exchange for his
shares both cash and shares of the stock of the publicly-owned
corporation.  The question presented is whether that payment of cash
had the "effect of the distribution of a dividend" within the meaning
of Section 356(a)(2) of the Internal Revenue Code.

                               STATEMENT

   For some time prior to April 1979, respondent Donald E. Clark /1/
was the president of Basin Surveys, Inc., a West Virginia corporation
that furnished radiation, nuclear, and electronic open-hole logging
services to the petroleum industry, and he owned all of its
outstanding 58 shares of stock.  N.L. Industries, Inc. (NL) was then a
publicly-held New Jersey corporation engaged in manufacturing and
supplying petroleum equipment and services, chemicals, and metals.  NL
had outstanding approximately 32,533,000 shares of a single class of
common stock and 500,000 shares of preferred stock.  That stock was
publicly traded on the New York and Pacific Stock Exchanges.  N.L.
Acquisition Corp. (NLAC) was a wholly owned subsidiary of NL.  App.,
infra, 16a.

   In 1978, NL had initiated discussions with respondent concerning
the possible acquisition of Basin.  After several months of
negotiations, NL offered respondent alternative terms for the
acquisition of Basin:  (1) 425,000 shares of NL common stock without
cash;  or (2) 300,000 shares of common stock and $3,250,000 in cash.
Respondent decided in favor of the latter alternative.  App., infra,
16a.  /2/

   On April 3, 1979, an agreement and plan of merger was executed by
Basin, NLAC, NL, and respondent.  The plan provided that, on April 18,
1979, Basin would merge with and into NLAC, which would change its
name to Basin Surveys, Inc., and that respondent would receive, with
respect to each of the 58 shares of Basin that he owned, 5,172.4137
shares of NL common stock and $56,034.482 in cash.  The merger took
place as planned.  Respondent received 300,000 shares of NL common
stock and $3,250,000 in cash, and he entered into an employment
agreement with Basin Surveys, Inc., for three years and an agreement
not to compete for five years.  The parties stipulated that the merger
of Basin into NLAC was effected pursuant to, and qualified as a
reorganization under, Section 368(a)(1)(A) and (a)(2)(D) of the
Internal Revenue Code.  /3/ App., infra, 16a-17a.

   2. Section 356(a)(1) of the Code provides that, it cash or other
property is recieved in the course of what would otherwise be a
tax-free, stock-for-stock reorganization, the recipient must recognize
has gain on the transaction up to the value of that other property
received.  Accordingly, in their joint federal income tax return for
1979, respondents reported the cash received in the merger, commonly
known as "boot," as taxable gain.  /4/ They characterized this amount
as long-term capital gain.  Section 356(a)(2) of the Code, however,
requires that, if the exchange "has the effect of a distribution of a
dividend," the recipient must treat the property received as a
dividend to the extent of his ratable share of the undistributed
earnings and profits of the corporation accumulated after February 28,
1913.  Under this Section, the Commissioner determined that $2,319,611
of the reported gain (i.e., the amount of the accumulated earnings and
profits of Basin at the time of the merger) should be treated as a
dividend and therefore taxable as ordinary income rather than as
capital gain.  This determination resulted in an asserted deficiency
of $972,504.74 in federal income taxes for 1979.

   3. Respondents petitioned for review in the Tax Court, which ruled
in their favor in a reviewed decision (App., infra, 15a-39a).  The
court viewed the question whether respondents' receipt of cash in the
merger had the effect of the distribution of a dividend as turning on
a choice between two "judicially articulated tests" set forth in
Wright v. United States, 482 F.2d 600 (8th Cir. 1973), and Shimberg v.
United States, 577 F.2d 283 (5th Cir. 1978), cert. denied, 439 U.S.
1115 (1979) (App., infra, 18a).  According to the Tax Court, the
Shimberg test would treat the cash distribution as if it constituted a
distribution by the acquired corporation prior to the merger, and the
Wright test would treat the cash payment as if it constituted "a
distribution by the acquiring corporation (NL) in a hypothetical
redemption of the shares of NL stock that would have been received if
petitioner had accepted stock in lieu of the cash consideration"
(App., infra, 18a (emphasis in original)).

   The Tax Court then concluded that it should follow Wright and treat
the cash payment as part of a post-merger hypothetical redemption of
the 125,000 shares of NL stock that respondent declined to accept as
payment.  The court stated that this approach was necessary if the
cash payment is to "be viewed and tested within the context of the
entire reorganization" (App., infra, 33a).  Because such a
hypothetical redemption would have reduced respondent's holdings in NL
from 425,000 to 300,000, it would not have been essentially equivalent
to a dividend under the redemption provisions of the Code (see Section
302(b)(2)).  /5/ Under the Tax Court's approach, this conclusion meant
that the cash received by respondents should not be viewed as a
dividend in the reorganization context either, and therefore
respondents were entitled to capital gain treatment upon the reported
gain.  App., infra, 34a-35a.

   4. The court of appeals affirmed (App., infra, 1a-14a).  Like the
Tax Court, the court of appeals approached the case as requiring it to
choose between Wright and Shimbert (see App., infra, 8a).  The court
first concluded that the dividend determination was to be made by
importing into the reorganization context the principles applicable to
redemptions under Section 302 of the Code (App., infra, 3a-6a).  The
court then concluded that the test of Section 302 should be applied as
if there had been a hypothetical redemption after the reorganization
was completed, and hence that whether the cash payment was a dividend
turned on the extent of the reduction in respondent's interest in NL
occasioned by the hypothetical redemption (App., infra, 7a-11a).  The
court criticized the Shimberg approach of treating the cash payment as
being made by the acquired corporation (App., infra, 10a-14a),
stating, inter alia, that it failed adequately to consider "the
corporate control he retained after the reorganization was completed"
(id. at 10a-11a).

                   REASONS FOR GRANTING THE PETITION

   The court of appeals' decision in this case has created a clear
conflict in the circuits with respect to the treatment under Section
356(a)(2) of the Code of cash or other property received in a
reorganization.  This conflict, if allowed to persist, will create
severe administrative problems for the Internal Revenue Service.
Depending on their situation, different types of shareholders have
different preferences for the treatment of the cash that they receive
in a reorganization.  Accordingly, regardless of which of the court of
appeals decisions that it follows, the IRS can expect some taxpayers
to challenge its treatment.  Unless the conflict is resolved,
therefore, the issue presented here is destined to remain a continual
source of dispute and litigation.  Moreover, the decision below
unjustifiably departs from a long line of contrary authority on a
recurring issue on which there are frequently large sums of money at
stake.  For these reasons, it is appropriate for this Court to grant
certiorari to resolve the conflict.

   1. There can be no doubt that the decision below directly conflicts
with Shimberg v. United States, 577 F.2d 283 (5th Cir. 1978), cert.
denied, 439 U.S. 1115 (1979).  As the Tax Court noted (App., infra,
27a), Shimberg involved "a factual set of circumstances similar to the
instant case," and there is no principled basis for reaching a
different result in the two cases.  In Shimbert a small corporation
was merged into a larger one, and the shareholders of the acquired
corporation received shares in the acquiring corporation, plus
$625,000 in cash, to be allocated among the shareholders on a pro rata
basis.  Shimberg, who owned a majority of the shares of stock in the
acquired corporation, reported his share of the cash received as
long-term capital gain, but the Commissioner determined that it should
be taxed as a dividend.

   The court of appeals in Shimberg rejected the taxpayer's contention
that redemption principles -- namely, whether receipt of the cash in a
hypothetical redemption of his shares in the acquiring corporation
would have resulted in a meaningful reduction of his interest in that
corporation -- should be applied to determine whether the cash was
equivalent to a dividend.  The court stated (577 F.2d at 287 (footnote
omitted)):  "We agree with the government that 'the undifferentiating
invocation of stock redemption principles in a reorganization case'
such as this one is erroneous, and we decline to apply on a wholesale
basis the 'meaningful reduction' test in cases arising under Section
356(a)(2)." Rather, the court explained, a "dividend" is generally
defined by Section 316(a) of the Code as "any distribution of property
made by a corporation to its shareholders * * * out of its earnings
and profits." Accordingly, "(i)f a pro rate distribution of profits
from a continuing corporation is a dividend, and a corporate
reorganization is a 'continuance of the proprietary interests in the
continuing enterprise under modified corporate form,' it follows that
the pro rata distribution of 'boot' to shareholders of one of the
participating corporations must certainly have the 'effect of the
distribution of a dividend' within the meaning of Section 356(a)(2)."
The court concluded that "Section 356(a)(2) requires a determination
of whether the distribution would have been taxed as a dividend if
made prior to the reorganization or if no reorganization had
occurred." 577 F.2d at 288.

   It is evident that the holding of Shimberg is precisely the
contention that was rejected here, and, as the court of appeals
apparently recognized (see App., infra, 7a-8a, 13a-14a), the two
decisions are irreconcilable.  Moreover, the decision below also
conflicts with the decisions of other courts of appeals relied upon in
Shimberg (see 577 F.2d at 288) that recognized the appropriateness of
dividend treatment in situations parallel to that presented here.
See, e.g., King Enterprises, Inc., v. United States, 418 F.2d 511, 521
(Ct. Cl. 1969);  Hawkinson v. Commissioner, 235 F.2d 747, 751 (2d Cir.
1956);  Campbell v. Commissioner, 144 F.2d 177, 181-182 (3rd Cir.
1944);  see pages 14-16, infra.  Thus, unless the Court grants
certiorari here, different taxpayers will receive disparate tax
treatment on the same transaction depending upon the circuit in which
their case arises.

   2. The conflict in the circuits created by the decision below will
create substantial administrative problems for the IRS unless it is
resolved.  The issue presented here is one on which the respective
interests of individual shareholders and corporate shareholders have
long been sharply divergent.  At least since 1936, because of the tax
advantages of capital gains as opposed to ordinary income, it has been
in the interest of individual shareholders, like respondents, not to
have dividend treatment for gain recognized on boot received on a
reorganization.  On the other hand, corporate shareholders
participating in the same or similar transactions have preferred to
have such gain treated as a dividend, because of the deduction for
intercorporate dividends allowed by Section 243 of the Code (generally
85% under present law).  Thus, even if the Commissioner were to
abandon his longstanding position on this issue and were to adopt the
approach taken by the court below, that would not put an end to the
controversy over the treatment of boot.  It can reasonably be
anticipated that corporate shareholders, relying on Shimberg and the
cases cited therein, would challenge the Commissioner's new position
and argue for dividend treatment.  Thus, the only way to end the
controversy over the issue presented in this case is by means of a
definitive resolution of the conflict in the circuits.

   In the wake of the Tax Reform Act of 1986, which eliminated the
differential tax rates between capital gains and ordinary income, one
can expect a significant diminution in the number of individual
shareholders whose interests will be adversely affected by dividend
treatment of boot.  /6/ There will, however, remain shareholders in
this category;  individuals who have, or can carry forward, capital
losses on other transactions will want their gain in a reorganization
to be classified as capital gain, rather than as a dividend, so that
they will be able to take a full deduction for the capital losses (see
I.R.C. Section 1211(b)).  The 1986 Act will not affect the interests
of corporate shareholders.  Because of the intercorporate dividend
deduction, they retain the same interest in contesting any effort by
the Commissioner to deny dividend treatment to gain recognized on boot
received in a reorganization.

   Moreover, quite apart from the question of the characterization of
the gain recognized by the shareholders of the acquired corporation,
the conflict in the circuits injects considerable uncertainty into the
treatment of other important tax accounts.  The court below has held
that "the boot should be characterized as a post-reorganization stock
redemption by N.L." (App., infra, 7a).  If that characterization is
followed, it would necessitate several adjustments because, as
discussed in detail infra (at 21-22), the receipt of additional stock
that is subsequently redeemed has different collateral consequences
from the receipt of boot.  The receipt of additional shares in the
transaction, which has the effect of spreading thinner the total basis
transferred from the surrendered shares, means that the basis of each
individual share retained after the merger would be smaller than if
the boot were characterized as a dividend.  And because the gain
recognized on a redemption is reduced by the basis of the redeemed
shares, the gain recognized in the merger will be different depending
on whether the boot is characterized as a post-reorganization
redemption.  See pages 21-22, infra.

   The disparities created by the conflict are even more pronounced in
connection with the earnings and profits accounts.  Under Section
356(a)(2) dividend treatment, the accumulated earnings and profits of
the acquired corporation would be depleted by the amount of the
dividend, and those earnings and profits would not be available for
future dividends issued by the reorganized entity.  On the other hand,
if the boot is treated as coming from a hypothetical
post-reorganization redemption, the earnings and profits of the
acquired corporation ought to survive in the reorganized entity.
Instead, the redemption presumably would draw upon the earnings and
profits of the corporation whose stock was being redeemed;  on the
facts of this case, for example, that would lead to a substantially
different post-reorganization earnings and profits structure (see
pages 21-22, infra).  /7/ Thus, the difference between treating the
boot as a dividend issued by the acquired corporation, on the one
hand, and as a hypothetical post-reorganization redemption, on the
other, may be reflected in continuing accounts, like basis and
earnings and profits, that will have tax effects -- and may lead to
disputes -- many years after the reorganization is complete.  /8/
Accordingly, it is of considerable importance for the Commissioner to
know at the outset how to treat these transactions and to be able to
apply a uniform rule nationwide.  In sum, the 1986 Act does not
eliminate the need to resolve the conflict in the circuits in order to
permit the Commissioner to avoid an administrative quandary.

   Moreover, while it is possible that litigation in this area will
increase now that the Fourth Circuit has flatly rejected a published
IRS position that has been accepted by several courts, it must be
emphasized that the administrative difficulties caused by this
conflict would not be restricted to the litigation arena.  The area of
corporate reorganizations is one that involves considerable planning
and often includes a request for a private letter ruling from the IRS.
 The IRS reports that it has issued 190 letter rulings since 1982 on
reorganizations involving boot;  110 of these contained explicit
rulings on treatment of boot under Section 356(a)(2).  Each ruling for
a particular reorganization will be applicable to an undisclosed,
often large, number of shareholders.  And a single reorganization may
involve both corporate and individual shareholders, whose interests
will likely be at odds, and shareholders who reside in different
circuits, where the precedent governing the treatment of boot is
irreconcilable.  It is essential for the IRS to have a uniform rule to
apply in issuing these rulings.

   3. The court of appeals erred in refusing to treat the boot
received by respondents as a dividend.  Section 316 of the Code
provides that "the term 'dividend' means any distribution of property
made by a corporation to its shareholders (1) out of its earnings and
profits accumulated after February 28, 1913, or (2) out of its
earnings and profits of the taxable year * * *." It further provides
that "(e)xcept as otherwise provided in this subtitle, every
distribution is made out of earnings and profits to the extent thereof
* * * ." Section 317 in turn defines "property" for these purposes as
"money, securities, and any other property." The Court summarized the
effect of these provisions as follows (Commissioner v. Gordon, 391
U.S. 83, 88-89 (1968)(footnote omitted)):

         Under Sections 301 and 316 of the Code, and subject to the
      specific exceptions and qualifications provided in the Code, any
      distribution of property by a corporation to its shareholders
      out of accumulated earnings and profits is a dividend taxable to
      the shareholders as ordinary income.  Every distribution of
      corporate property, again except as otherwise specifically
      provided, "is made out of earnings and profits to the extent
      thereof."

   The reorganization provisions of the Code have their origin in the
Revenue Act of 1921, ch. 136, 42 Stat. 227.  In order to "permit
business to go forward with the readjustments required by existing
conditions without the immediate imposition of taxes" (S. Rep. 275,
67th Cong., 1st Sess. 11 (1921)), Section 202(c)(2) of that Act (42
Stat. 230) provided that no gain or loss should be recognized upon an
exchange of stock or securities in one corporation that is a party to
the reorganization for stock or securities in another corporation that
is a party to the reorganization.  Section 202(d)(1)(42 Stat. 230)
instead provides that the stock or securities received on the exchange
should take the same basis in the hands of the taxpayer as the
surrendered stock or securities.  This statutory structure (now
codified in I.R.C. Sections 354, 358 and 368) embodies the principle
that such a stock-for-stock reorganization is "a continuance of the
proprietary interests in the continuing enterprise under modified
corporate form" (Lewis v. Commissioner, 176 F.2d 646, 648 (1st Cir.
1949)).  See also Treas. Reg. Section 1.368-1(b).

   In 1924, Congress refined the reorganization provisions that it had
enacted three years earlier by addressing the treatment of a payment
of cash, in addition to the stock or securities received tax-free, to
the shareholders of one of the reorganizing corporations.  It enacted
the predecessor to Section 356(a) of the Code, Section 203(d) of the
Revenue Act of 1924, ch. 234, 43 Stat. 257, which provided that (1)
if, in addition to eligible stock or securities, money or other
property, but (2) if such a distribution "has the effect of the
distribution of a taxable dividend, then there shall be taxed as a
dividend to each distributee" the amount of the gain that does not
exceed his share of undistributed earnings and profits.  Congress
indicated that this provision was necessary to account accurately for
distributions in the context of a reorganization that had the same
effect "as if the corporation had declared out (the cash) as a
dividend" directly without the reorganization.  See H.R. Rep. 179,
68th Cong., 1st Sess. 15-16 (1924);  S. Rep. 398, 68th Cong., 1st
Sess. 15-16 (1924).

   The logical import of all of these provisions is that boot in a
reorganization that is distributed pro rata to the shareholders of one
of the corporations should be treated as a dividend.  A pro rata
distribution of cash from a corporation to its shareholders is the
classical form of dividend.  And the reorganization provisions are
desinged to reflect the fact that the new corporation is a
continuation of the same enterprise of the acquired corporation.
Accordingly, the pro rate "distribution of property" made in the
course of the reorganization to the shareholders of one of the
corporations almost falls within the specific terms of the definition
of "dividend" in Section 316 and should be viewed as "essentially
equivalent to a dividend" within the meaning of Section 356(a)(2).

   In this vein, a long line of court of appeals' decisions in the
wake of the 1924 Act recognized that, where two corporations not
previously under common control are unified either by statutory merger
or consolidation (I.R.C. Section 368(a)(1)(A)) or by the transfer of
substantially all of the assets of one to the other in exchange for
voting stock of the latter (I.R.C. Section 368(a)(1)(C)), and the
shareholders of one or both corporations receive a pro rata payment of
cash, that payment has the effect of a dividend and is to be taxed as
such.  The first case in this line is Commissioner v. Owens, 69 F.2d
597 (5th Cir. 1934), where two banks merged and the shareholders of
the smaller bank received pro rata both stock in the new bank and
cash.  The court held that "so much of (the cash) as might before
consolidating have been declared by their corporation as an ordinary
dividend out of its profits is by (the predecessor of Section
356(a)(2)) to be so taxed" (69 F.2d at 598).  The court specifically
noted (ibid.):  "It is true that the money was not distributed by the
(acquired bank) and thus was not literally a dividend of that bank.
But the statute speaks of a distribution which 'has the effect of the
distribution of a dividend.' This pro rata payment to all stockholders
of the (acquired bank) * * * certanly has that effect."

   Subsequent to Owens, several other courts of appeals reached the
same conclusion regarding boot received on a pro rata basis.  See King
Enterprises, Inc. v. United States, 418 F.2d at 521 ("The distribution
on a pro rata basis, entailing no substantially disproportionate
change in the continuing equity interests of the Tenco stockholders,
constitutes a classic example of a transaction having the effect of
the distribution of a dividend."), Hawkinson v. Commissioner, 235 F.2d
at 751 ("the distribution had all the earmarks of a taxable dividend,
i.e., a pro rata distribution out of corporate earnings and profits");
 Campbell v. Commissioner, 144 F.2d at 182 ("We (previously) held that
when cash was distributed in a reorganization to the stock holders of
the predecessor company that part of the amount thus distributed which
equalled the accumulated earnings of the predecessor corporation had
the effect of a taxable dividend and was accordingly taxable as
such");  see also Ross v. United States, 173 F. Supp. 793, 798 (Ct.
Cl), cert. denied, 361 U.S. 875 (1959);  Rose v. Little Investment
Co., 86 F.2d 50 (5th Cir. 1936);  commissioner v. Forhan Realty Corp.,
75 F.2d 268 (2d Cir. 1935);  Sheldon v. Commissioner, 6 T.C. 510
(1946);  Woodward v. Commissioner, 30 B.T.A. 1259 (1931).  /9/ On the
other hand, where the cash payment was not pro rata to the
shareholders of one of the corporations, but rather was made only to
holders of preferred stock who did not own any common stock in order
to call and retire that preferred stock, the payment was held not to
have the effect of a dividend.  Idaho Power Co. v. United States, 161
F. Supp. 807 (Ct. Cl.), cert. denied, 358 U.S. 832 (1958).  This line
of authority was capped by Shimberg v. United States, supra, which
rejected the precise contention accepted by the court below (see pages
6-8, supra).  See also General Housewares Corp. v. United States, 615
F.2d 1056, 1066 (5th Cir. 1980).  /10/

   Indeed, the existence of this established line of authority was
noted approvingly by this Court in Commissioner v. Estate of Bedford,
325 U.S. 283 (1945).  That case dealt with a factual situation
somewhat different from the one here.  The estate in Bedford was a
shareholder of a corporation that engaged in a recapitalization or "E"
reorganization.  In exchange for 3,000 shares of preferred stock, the
estate received 3,500 shares of a lesser preferred, 1,500 shares of
common stock, and $45,240 in cash.  The Court held that the cash came
out of the corporation's accumulated earnings and hence had the effect
of a dividend and was taxable at ordinary, rather than capital, gain
rates.  The court referred with approval to several of the cases cited
above requiring dividend treatment in the case of reorganizations
involving two corporations, and it stated (id. at 291):  "We cannot
distinguish the two situations and find no implication in the statute
restricting (the predecessor of Section 356(a)(2)) to taxation as a
dividend only in the case of an exchange of stock and assets of two
corporations." /11/

   Against this uniform body of decisional law, the court below
erroneously relied upon Wright v. United States, 482 F.2d 600 (8th
Cir. 1973), which arose in a very different factual context.  Wright
was the principal shareholder in three different corporations engaged
in construction and equipment leasing.  Wright owned 71.5% of the
stock of the construction company, and his field superintendent owned
27.9%.  They wanted to merge the other two companies and create a new
company (Omni) that would have a stock ownership ratio similar to that
of the construction company.  A simple stock-for-stock reorganization,
however, would have given Wright a greater share of Omni than he
desired.  Therefore, the merger plan provided that, in addition to the
exchange of stock in the two old companies for stock in Omni, the
superintendent would purchase additional shares of Omni and Omni would
issue a promissory note to Wright.  This promissory note was boot, and
the court of appeals rejected the Commissioner's contention that it
had the effect of a dividend.  The court noted that "(t)he
corporations involved did not exist separately but were owned and
controlled by the same shareholders but in different proportions" (id.
at 607).  On that basis, the court concluded that "the note was issued
by Omni in exhange for a portion of Omni stock that the taxpayer would
have received if he had taken Omni stock entirely instead of receiving
Omni stock and a note issued to him by Omni" (ibid.).  The court then
applied the provisions of Section 302 to measure the effect of this
hypothetical redemption on Wright's interest in Omni and concluded
that there was a meaningful reduction in his percentage interest that
precluded dividend treatment.

   The Fifth Circuit in Shimberg recognized that Wright was
distinguishable because the commonality of ownership of the merging
corporations appeared to be the basis upon which the Eighth Circuit
had concluded that the distribution of boot should be treated like a
redemption of shares in a single corporation.  The Fifth Circuit
therefore remarked (577 F.2d at 287):  "Even assuming that Wright is
correctly decided -- a point on which we express no opinion -- the
instant case presents radically different facts and calls for
correspondingly different analysis." That observation is equally
applicable here.  For this reason, the court of appeals below clearly
erred in applying the "hypothetical redemption" approach of Wright to
this case, rather than the long line of authority requiring dividend
treatment for boot distributed to the shareholders of one corporation
on a pro rata basis.

   4. In the words of the Fifth Circuit in Shimberg, it was error for
the court below to embrace "the undifferentiating invocation of stock
redemption principles principles in a reorganization case such as this
one" (577 F.2d at 287).  To be sure, there is considerable similarity
between the redemption provisions and Section 356(a)(2);  both involve
an inquiry into whether a particular non-dividend distribution is
sufficiently akin to a dividend that it should be treated as one for
tax purposes.  At the same time, there are significant differences
between the two contexts to which these provisions apply -- for
example, the difference between a transaction involving a shareholder
and a single corporation as opposed to a consolidation involving two,
often unrelated, corporations.  These differences are substantial
enough to counsel against the incorporation of every nuance and detail
of Section 302 into the inquiry needed under Section 356(a)(2).

   In any event, in the context presented here, there is no tension
between the principles of Section 302 and the principles that should
be applied under Section 356(a)(2).  As discussed above, a pro rata
payment of boot should be treated as a dividend.  A distribution to a
sole shareholder, as in this case, is necessarily pro rata.  By the
same token, a pro rata redemption of stock, including the redemption
of some of the shares of a sole stockholder, is essentially equivalent
to a dividend and therefore taxable as a dividend under Section
302(d).  See United States v. Davis, 397 U.S. 301 (1970).  In short, a
pro rata payment of cash is the prototype transaction calling for
dividend treatment in both the reorganization and redemption contexts.
 This case, therefore, presents no occasion to consider to what extent
the detailed formulations of Section 302 should be applicable in the
case of boot that is not distributed on a pro rata basis or whether,
in such circumstances, a different result could obtain under Section
356(a)(2) from what would be indicated by Section 302.  /12/

   The court below concluded that the application of redemption
principles in the post-reorganization setting yielded capital gain
treatment of boot distributed to a sole shareholder.  It could reach
this conclusion only by assuming, contrary to fact, that respondent
had elected the choice that he consciously rejected, namely,
receiving, 425,000 shares of NL stock and no cash.  The court then
applied Section 302 to the hypothetical redemption of 125,000 of those
shares and concluded that the diminution in respondent's interest in
NL was sufficiently substantial to make the redemption (and hence the
receipt of boot) not equivalent to a dividend.

   This approach is seriously flawed.  First, it is generally true
that, "while a taxpayer is free to organize his affairs as he chooses,
nevertheless, once having done so, he must accept the tax consequences
of his choice," not of the alternative that he did not choose.
Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U.S.
134, 149 (1974).  See also Don E. Williams Co. v. Commissioner, 429
U.S. 569, 579-580 (1977).  In addition, the approach of the court
below creates substantial practical difficulties because it requires a
determination of how many shares the taxpayer would have received
instead of the boot if the transaction had been a stock-for-stock
reorganization followed by a redemption.  That determination happened
to be easy in this case because of the fortuity that respondent had
been offered two alternatives.  In cases that lack this unusual
aspect, and that involve difficult-to-value close corporations, it
will be quite difficult to construct the hypothetical redemption
required by the court of appeals.

   Moreover, the decision below is flawed because it seeks to equate
two transactions that differ in a number of important respects.  If
respondent had actually elected to receive all of the consideration in
the form of NL stock and then redeem a portion of it, the basic
accounting figures generated by the transaction would not have been
the same.  The total basis of the stock received by respondent in the
merger, which derives from the basis in the old stock he exchanged,
must be allocated over the total number of shares received.  Thus, the
basis of each individual share obviously is going to be different
depending upon whether the total basis is allocated over the 300,000
shares actually received in the merger or over the 425,000 shares that
would have been received in the transaction assumed by the court of
appeals.  And, because the gain recognized on a redemption is reduced
by the basis of the redeemed shares, the gain recognized if respondent
had chosen the "no cash option" would have been different from the
gain recognized on the actual transaction involving boot.

   Another difference between the two transactions is the effect on
the earnings and profits accounts.  In the actual transaction, the
earnings and profits available for distribution as a dividend were
Basin's $2,319,611 in accumulated earnings and profits.  If respondent
had chosen the redemption option, however, the earnings and profits
would have been those of NL (a figure that is not in the record here
and that, in any event, bears no relation to Basin's or respondent's
history).  /13/ And the effect on earnings and profits is not the same
under Section 356(a)(2) as it is in the case of redemptions.  In the
former case, the statute specifically provides that the available
account is limited to accumulated earnings and profits.  In the case
of a redemption, the earnings and profits of the taxable year are also
available (see Estate of Uris v. Commissioner, 605 F.2d 1258 (2d Cir.
1979);  Baker v. United States, 460 F.2d 827, 832-835 (8th Cir.
1972)), and a portion of the redemption would have drawn upon a share
of NL'S capital (see Foster v. United States, 303 U.S. 118 (1938)).
These significant differences cast considerable doubt upon the
validity of a doctrine that assumes that the two transactions are
equivalent.

   In sum, respondent presumable acted prudently and according to his
best judgment in choosing to take cash and stock upon the merger of
his corporation into NLAC, rather than committing substantially all of
his resources to a large corporation in which he would be a minority
shareholder (see note 2, supra).  The court below erred in relieving
him of the tax consequences of that choice and instead giving him the
tax consequences of the option that he declined.  The court should
have followed established precedent and treated the boot actually
received as a dividend to the extent of Basin's earnings and profits.

                              CONCLUSION

   The petition for a writ of certiorari should be granted.

   Respectfully submitted.

   DONALD B. AYER

      Acting Solicitor General /*/

   WILLIAM S. ROSE, JR.

      Assistant Attorney General

   LAWRENCE G. WALLACE

      Deputy Solicitor General

   ALAN I. HOROWITZ

      Assistant to the Solicitor General

   ERNEST J. BROWN

      Attorney

   JANUARY 1988

   /1/ Respondent Peggy S. Clark is a party herein only because she
filed a joint federal income tax return for the calender year 1979
with her husband, respondent Donald E. Clark.  References to
"respondent" in the singular will be to Donald E. Clark.

   /2/ In the Tax Court, respondent's attorney testified (and it was
agreed that, if called, respondent would testify to the same effect)
that, after receiving NL's alternative officers, respondent had
requested the NL representatives to leave the room, so that the two of
them could discuss the matter.  In that discussion, the factors that
led to a tentative choice of the latter alternative were that
respondent's "whole livelihood was tied up in his company," and that
an all-stock deal would involve the risk of serious loss if something
happened to NL.  Moreover, the stock of NL that was to be received
would not be registered stock, but would be restricted letter stock,
which would mean, under SEC rules, that respondent would have to hold
the stock for a couple of years if he wanted to sell it and receive
full value.  And, in view of respondent's complete involvement with
his company, that, in turn, would have meant that he could not pay his
outstanding bills.  C.A. App. 48-53.

   /3/ Unless otherwise noted, all statutory references are to the
Internal Revenue Code (26 U.S.C.), as amended (the Code or I.R.C.).

   /4/ The figure reported by respondents on their return was
$3,195,294.  In their later computation for entry of decision by the
Tax Court, respondents acknowledged that the amount of gain recognized
and reported should have been $3,250,000.

   /5/ Under the "safe harbor" provisions of Section 302(b)(2), cash
received upon a "subtantially disproportionate redemption" will not be
treated as a dividend.  The statute defines such a redemption as one
in which the shareholder's percentage interest in voting stock in the
corporation following the redemption is less than 80% of what it was
before the redemption and he retains less than 50% of the voting power
in the corporation following the redemption.

   /6/ Congress, however, apparently viewed the elimination of the
differential tax rates for capital gain and ordinary income, which had
been part of the revenue laws since 1921, as something of an
experiment.  Congress stated that it was retaining the existing
statutory structure for capital gains in the Code in order "to
facilitate reinstatement of a capital gains rate differential if there
is a future tax rate increase." H.R. Rep. 99-841, 99th Cong., 2d Sess.
Pt. II, at 106 (1986).

   /7/ Moreover, if the transaction is truly to be treated as a
redemption, there would be additional differences because a redemption
may draw upon capital and upon both accumulated earnings and profits
and also those for the taxable year, whereas a Section 356(a)(2)
dividend draws only upon accumulated earnings and profits.  See page
22, infra.

   /8/ See, e.g., Commissioner v. Phipps, 336 U.S. 410 (1949);
Commissioner v. Munter, 331 U.S. 210 (1947);  Foster v. United States,
303 U.S. 118 (1938).

   /9/ All of these cases, like the present one, involve "A" or "C"
reorganizations of corporations not under common control.  There are
many more cases requiring dividend treatment for boot received in a
"D" reorganization ("a transfer by a corporation of all or a part of
its assets to another corporation if immediately after the transfer
the transferor, or one or more of its shareholders * * * is in control
of the corporation to which the assets are transferred," I.R.C.
Section 368(a)(1)(D)).  See e.g., DeGroff v. Commissioner, 444 F.2d
1385 (10th Cir. 1971);  Liddon v. Commissioner, 230 F.2d 304 (6th
Cir.), cert. denied, 352 U.S. 824 (1956);  Lewis v. Commissioner, 176
F.2d 646 (1st Cir. 1949);  Love v. Commissioner, 113 F.2d 236 (3d Cir.
1940);  cf. Pridemark, Inc. v. Commissioner, 345 F.2d 35 (4th Cir.
1965).

   /10/ These cases uniformly recognize that dividend treatment does
not turn upon which corporation physically pays out the cash to the
shareholders.  Whether the immediate source of the cash is the
acquiring corporation, the acquired corporation, or the new
corporation, a pro rata distribution to the shareholders of one
corporation is a dividend to the extent of the accumulated earnings
and profits of that latter corporation.  See Shimberg v. United
States, 577 F.2d at 289;  Ross v. United States, 173 F.Supp. at 798;
Campbell v. Commissioner, 144 F.2d at 182;  Commissioner v. Owens, 69
F.2d at 598;  Woodward v. Commissioner, 23 B.T.A. at 1362.

   /11/ In the course of rejecting an alternative argument made by the
estate, the Court made the statement that "a distribution, pursuant to
a reorganization, of earnings and profits 'has the effect of a
distribution of a taxable dividend'" (325 U.S. at 292).  This
statement was read by some as establishing an "automatic dividend"
rule that would accord dividend treatment to any cash received on a
reorganization, whether pro rata or not.  This "automatic dividend"
rule was heavily critized by the commentators (see, e.g., Shoulson,
Boot Taxation:  The Blunt Toe of the Automatic Rule, 20 Tax L. Rev.
573 (1965);  Darrell, The Scope of Commissioner v. Bedford Estate, 24
Taxes 266, 268-276 (1946)).  The post-Bedford cases in this area,
however, have rejected this broad reading and have concluded that this
Court was not attempting to establish a rule that would extend to
cases not involving a pro rata distribution, which was not what was
involved in Bedford.  See Shimberg v. United States, 577 F.2d at 290 &
n.19;  King Enterprises, Inc. v. United States, 418 F.2d at 520;
Hawkinson v. Commissioner, 235 F.2d at 750-751;  Ross v. United
States, 173 F.Supp. at 797.  The IRS has also rejected this broad
reading of Bedford.  See Rev. Rul. 74-515, 1974-2 C.B. 118;  Rev. Rul.
74-516, 1974-2 C.B. 121.  Because the present case involves a pro rata
distribution of boot, the court of appeals erred in suggesting (App.,
infra, 11a-12a) that the government's contention here seeks to
"resurrect() the abandoned automatic dividend rule of Bedford."

   /12/ The court in Shimberg noted that it did not totally reject the
relevance of redemption principles in the context of a reorganization
(577 F.2d at 290).  By the same token, the Commissioner has stated
that the principles developed under Section 302 for determining
dividend equivalency may "in appropriate cases" serve as "useful
guidelines for purposes of applying Section 356(a)(2)." Rev. Rul.
74-516, 1974-2 C.B. 121.  But these principles come into play only in
the context of a non-pro-rata distribution;  otherwise, the payment is
clearly a dividend.  Thus, they have no application here.  For this
reason, the example of a non-pro-rata distribution that the court of
appeals put forth as demonstrating a flaw in the Commissioner's
position (see App., infra, 12a was quite irrelevant.

   /13/ Because Basin did not merge into NL, but rather into its
subsidiary, NLAC, Basin's earnings and profits would not be involved
in the redemption of NL stock.

   /*/ The Solicitor General is disqualified in this case.

   APPENDIX