Brown v. Illinois, 422 U.S. 590 (1975)
Case details
Citation
422 U.S. 590
Country
United States
Jurisdiction
Federal
Court
Supreme Court of the United States
Decided
June 26, 1975
Disposition
56 Ill. 2d 312, 307 N. E. 2d 356, reversed and remanded
Concurrence
White (Justice) in the judgment
BROWN v. ILLINOIS
CERTIORARI TO THE SUPREME COURT OF ILLINOIS
No. 73-6650. Argued March 18, 1975—Decided June 26, 1975
Petitioner, who had been arrested without probable cause and
without a warrant, and under circumstances indicating that the arrest was investigatory, made two in-custody inculpatory statements after he had been given the warnings prescribed by Miranda v. Arizona, 384 U. S. 436. Thereafter indicted for murder, petitioner filed a pretrial motion to suppress the statements. The motion was overruled and the statements were used in the trial, which resulted in petitioner’s conviction. The State Supreme Court, though recognizing the unlawfulness of petitioner’s arrest, held that the statements were admissible on the ground that the giving of the Miranda warnings served to break the causal connection between the illegal arrest and the giving of the statements, and petitioner’s act in making the statements was “sufficiently an act of free will to purge the primary taint of the unlawful invasion.” Wong Sun v. United States, 371 U. S. 471, 486. Held:
1. The Illinois courts erred in adopting a per se rule that
Miranda warnings in and of themselves broke the causal chain so that any subsequent statement, even one induced by the continuing effects of unconstitutional custody, was admissible so long as, in the traditional sense, it was voluntary and not coerced in violation of the Fifth and Fourteenth Amendments. When the exclusionary rule is used to effectuate the Fourth Amendment, it serves interests and policies that are distinct from those it serves under the Fifth, being directed at all unlawful searches and seizures, and not merely those that happen to produce incriminating material or testimony as fruits. Thus, even if the statements in this case were found to be voluntary under the Fifth Amendment, the Fourth Amendment issue remains. Wong Sun requires not merely that a statement meet the Fifth Amendment voluntariness standard but that it be “sufficiently an act of free will to purge the primary taint” in light of the distinct policies and interests of the Fourth Amendment. Pp. 600-603.
2. The question whether a confession is voluntary under Wong
Sun must be answered on the facts of each case. Though the
Miranda warnings are an important factor in resolving the issue, other factors must be considered; and the burden of showing admissibility of in-custody statements of persons who have been illegally arrested rests on the prosecutor. Pp. 603-604.
3. The State failed to sustain its burden in this case of showing
that petitioner’s statements were admissible under Wong Sun. Pp. 604-605. 56 Ill. 2d 312, 307 N. E. 2d 356, reversed and remanded.
Bla ckmu n , J., delivered the opinion of the Court, in which Bur ge r , C. J., and Dou gl as , Bre nn an , Ste wa rt , and Mar shal l , JJ., joined. Whi te , J., filed an opinion concurring in the judgment, post, p. 606. Pow el l , J., filed an opinion concurring in part, in which Reh nq ui st , J., joined, post, p. 606.
Robert P. Isaacson argued the cause for petitioner pro hac vice. With him on the brief were James J. Doherty and John T. Moran.
Jayne A. Carr, Assistant Attorney General of Illinois, argued the cause for respondent. With her on the brief were William J. Scott, Attorney General, and James B. Zagel, Assistant Attorney General.*
Mr . Just ice Blackmu n delivered the opinion of the Court.
This case lies at the crossroads of the Fourth and the Fifth Amendments. Petitioner was arrested without probable cause and without a warrant. He was given, in full, the warnings prescribed by Miranda v. Arizona, 384 U. S. 436 (1966). Thereafter, while in custody, he made two inculpatory statements. The issue is whether evidence of those statements was properly admitted, or should have been excluded, in petitioner’s subsequent trial for murder in state court. Expressed another way, the issue is whether the statements were to be excluded
*Solicitor General Bork and Acting Assistant Attorney General Keeney filed a memorandum for the United States as amicus curiae. p. 592as the fruit of the illegal arrest, or were admissible because the giving of the Miranda warnings sufficiently attenuated the taint of the arrest. See Wong Sun v. United States, 371 U. S. 471 (1963). The Fourth Amendment, of course, has been held to be applicable to the States through the Fourteenth Amendment. Mapp v. Ohio, 367 U. S. 643 (1961).
I
As petitioner Richard Brown was climbing the last of the stairs leading to the rear entrance of his Chicago apartment in the early evening of May 13, 1968, he happened to glance at the window near the door. He saw, pointed at him through the window, a revolver held by a stranger who was inside the apartment. The man said: “Don’t move, you are under arrest.” App. 42. Another man, also with a gun, came up behind Brown and repeated the statement that he was under arrest. It was about 7:45 p. m. The two men turned out to be Detectives William Nolan and William Lenz of the Chicago police force. It is not clear from the record exactly when they advised Brown of their identity, but it is not disputed that they broke into his apartment, searched it, and then arrested Brown, all without probable cause and without any warrant, when he arrived. They later testified that they made the arrest for the purpose of questioning Brown as part of their investigation of the murder of a man named Roger Corpus.
Corpus was murdered one week earlier, on May 6, with a .38-caliber revolver in his Chicago West Side second-floor apartment. Shortly thereafter, Detective Lenz obtained petitioner’s name, among others, from Corpus’ brother. Petitioner and the others were identified as acquaintances of the victim, not as suspects.1
On the day of petitioner’s arrest, Detectives Lenz and Nolan, armed with a photograph of Brown, and another officer arrived at petitioner’s apartment about 5 p. m. App. 77, 78. While the third officer covered the front entrance downstairs, the two detectives broke into Brown’s apartment and searched it. Id., at 86. Lenz then positioned himself near the rear door and watched through the adjacent window which opened onto the back porch. Nolan sat near the front door. He described the situation at the later suppression hearing:
“After we were there for a while, Detective Lenz told me that somebody was coming up the back stairs. I walked out the front door through the hall and around the corner, and I stayed there behind a door leading on to the back porch. At this time I heard Detective Lenz say, ‘Don’t move, you are under arrest.’ I looked out. I saw Mr. Brown backing away from the window. I walked up behind him, I told him he is under arrest, come back inside the apartment with us.” Id., at 42. As both officers held him at gunpoint, the three entered the apartment. Brown was ordered to stand against the wall and was searched. No weapon was found. Id., at 93. He was asked his name. When he denied being Richard Brown, Detective Lenz showed him the photograph, informed him that he was under arrest for the murder of Roger Corpus, id., at 16, handcuffed him, id., at 93, and escorted him to the squad car.
The two detectives took petitioner to the Maxwell Street police station. During the 20-minute drive Nolan again asked Brown, who then was sitting with him in the back seat of the car, whether his name was Richard Brown and whether he owned a 1966 Oldsmobile. Brown p. 594alternately evaded these questions or answered them falsely. Tr. 74. Upon arrival at the station house Brown was placed in the second-floor central interrogation room. The room was bare, except for a table and four chairs. He was left alone, apparently without handcuffs, for some minutes while the officers obtained the file on the Corpus homicide. They returned with the file, sat down at the table, one across from Brown and the other to his left, and spread the file on the table in front of him. App. 19.
The officers warned Brown of his rights under Miranda.2 Ibid. They then informed him that they knew of an incident that had occurred in a poolroom on May 5, when Brown, angry at having been cheated at dice, fired a shot from a revolver into the ceiling. Brown answered: “Oh, you know about that.” Id., at 20. Lenz informed him that a bullet had been obtained from the ceiling of the poolroom and had been taken to the crime laboratory to be compared with bullets taken from Corpus’ body.3 Ibid. Brown responded: “Oh, you know that, too.” Id., at 20-21. At this point—it was about 8:45 p. m.—Lenz asked Brown whether he wanted to talk about the Corpus homicide. Petitioner answered that he did. For the next 20 to 25 minutes Brown answered questions put to him by Nolan, as Lenz typed. Id., at 21-23.
This questioning produced a two-page statement in which Brown acknowledged that he and a man named
2 There is no assertion here that he did not understand those rights.
3 It was stipulated at the trial that if expert testimony were taken, it would be to the effect that the bullet eventually was ascertained to be a “wiped bullet,” that is, that its sides were “clean and therefore it was not ballistically comparable to any other bullets, specifically the bullets taken from the body of the deceased, Roger Corpus.” Tr. 543. p. 595Jimmy Claggett visited Corpus on the evening of May 5; that the three for some time sat drinking and smoking marihuana; that Claggett ordered him at gunpoint to bind Corpus’ hands and feet with cord from the headphone of a stereo set; and that Claggett, using a .38-caliber revolver sold to him by Brown, shot Corpus three times through a pillow. The statement was signed by Brown. Id., at 9, 38.
About 9:30 p. m. the two detectives and Brown left the station house to look for Claggett in an area of Chicago Brown knew him to frequent. They made a tour of that area but did not locate their quarry. They then went to police headquarters where they endeavored, without success, to obtain a photograph of Claggett. They resumed their search—it was now about lip. m.—and they finally observed Claggett crossing at an intersection. Lenz and Nolan arrested him. All four, the two detectives and the two arrested men, returned to the Maxwell Street station about 12:15 a. m. Id., at 39.
Brown was again placed in the interrogation room. He was given coffee and was left alone, for the most part, until 2 a. m. when Assistant State’s Attorney Crilly arrived.
Crilly, too, informed Brown of his Miranda rights. After a half hour’s conversation, a court reporter appeared. Once again the Miranda warnings were given: “I read him the card.” Id., at 30. Crilly told him that he “was sure he would be charged with murder.” Id., at 32. Brown gave a second statement, providing a factual account of the murder substantially in accord with his first statement, but containing factual inaccuracies with respect to his personal background.4 When the state-
4 In response to questions from Mr. Crilly, Brown stated that he was employed at E. I. Guffman Company in Niles, Ill., and that he was a punch press operator, App. 97, whereas he later conceded p. 596ment was completed, at about 3 a. m., Brown refused to sign it. Id., at 57. An hour later he made a phone call to his mother. At 9:30 that morning, about 14 hours after his arrest, he was taken before a magistrate.
On June 20 Brown and Claggett were jointly indicted by a Cook County grand jury for Corpus’ murder. Prior to trial, petitioner moved to suppress the two statements he had made. He alleged that his arrest and detention had been illegal and that the statements were taken from him in violation of his constitutional rights. After a hearing, the motion was denied. R. 46.
The case proceeded to trial. The State introduced evidence of both statements. Detective Nolan testified as to the contents of the first, App. 89-92, but the writing itself was not placed in evidence. The second statement was introduced and was read to the jury in full. Tr. 509-528. Brown was 23 at the time of the trial. Id., at 543.
The jury found petitioner guilty of murder. R. 80. He was sentenced to imprisonment for not less than 15 years nor more than 30 years. Id., at 83.
On appeal, the Supreme Court of Illinois affirmed the judgment of conviction. 56 Ill. 2d 312, 307 N. E. 2d 356 (1974). The court refused to accept the State’s argument that Brown’s arrest was lawful. “Upon review of the record, we conclude that the testimony fails to show that at the time of his apprehension there was probable cause for defendant’s arrest, [and] that his arrest was, therefore, unlawful.” Id., at 315, 307 N. E.
that he worked at Arnold Schwinn Bicycle Company and had never worked at any other place. Id., at 63. He also remarked in the Crilly statement that he had completed three years of high school, id., at 96, whereas later he conceded that he “never went to high school.” Id., at 58. p. 5972d, at 357. But it went on to hold in two significant and unembellished sentences:
“(W]e conclude that the giving of the Miranda warnings, in the first instance by the police officer and in the second by the assistant State’s Attorney, served to break the causal connection between the illegal arrest and the giving of the statements, and that defendant’s act in making the statements was ‘sufficiently an act of free will to purge the primary taint of the unlawful invasion.’ (Wong Sun v. United States, 371 U. S. 471, at 486.) We hold, therefore, that the circuit court did not err in admitting the statements into evidence.” Id., at 317, 307 N. E. 2d, at 358. Aside from its reliance upon the presence of the Miranda warnings, no specific aspect of the record or of the circumstances was cited by the court in support of its conclusion. The court, in other words, appears to have held that the Miranda warnings in and of themselves broke the causal chain so that any subsequent statement, even one induced by the continuing effects of unconstitutional custody, was admissible so long as, in the traditional sense, it was voluntary and not coerced in violation of the Fifth and Fourteenth Amendments.
Because of our concern about the implication of our holding in Wong Sun v. United States, 371 U. S. 471 (1963), to the facts of Brown’s case, we granted certiorari. 419 U. S. 894 (1974).
II
In Wong Sun, the Court pronounced the principles to be applied where the issue is whether statements and other evidence obtained after an illegal arrest or search should be excluded. In that case, federal agents elicited an oral statement from defendant Toy after forcing entry p. 598at 6 a. m. into his laundry, at the back of which he had his living quarters. The agents had followed Toy down the hall to the bedroom and there had placed him under arrest. The Court of Appeals found that there was no probable cause for the arrest. This Court concluded that that finding was “amply justified by the facts clearly shown on this record.” 371 U. S., at 479. Toy’s statement, which bore upon his participation in the sale of narcotics, led the agents to question another person, Johnny Yee, who actually possessed narcotics. Yee stated that heroin had been brought to him earlier by Toy and another Chinese known to him only as “Sea Dog.” Under questioning, Toy said that “Sea Dog” was Wong Sun. Toy led agents to a multifamily dwelling where, he said, Wong Sun lived. Gaining admittance to the building through a bell and buzzer, the agents climbed the stairs and entered the apartment. One went into the back room and brought Wong Sun out in handcuffs. After arraignment, Wong Sun was released on his own recognizance. Several days later, he returned voluntarily to give an unsigned confession.
This Court ruled that Toy’s declarations and the contraband taken from Yee were the fruits of the agents’ illegal action and should not have been admitted as evidence against Toy. Id., at 484-488. It held that the statement did not result from “ ‘an intervening independent act of a free will,’ ” and that it was not “sufficiently an act of free will to purge the primary taint of the unlawful invasion.” Id., at 486. With respect to Wong Sun’s confession, however, the Court held that in the light of his lawful arraignment and release on his own recognizance, and of his return voluntarily several days later to make the statement, the connection between his unlawful arrest and the statement “had ‘become so attenuated as to dissipate the taint.’ Nardone v. United p. 599States, 308 U. S. 338, 341.” Id., at 491. The Court said:
“We need not hold that all evidence is ‘fruit of the poisonous tree’ simply because it would not have come to light but for the illegal actions of the police. Rather, the more apt question in such a case is ‘whether, granting establishment of the primary illegality, the evidence to which instant objection is made has been come at by exploitation of that illegality or instead by means sufficiently distinguishable to be purged of the primary taint.’ Maguire, Evidence of Guilt, 221 (1959).” Id., at 487-488.
The exclusionary rule thus was applied in Wong Sun primarily to protect Fourth Amendment rights. Protection of the Fifth Amendment right against self-incrimi-nation was not the Court’s paramount concern there. To the extent that the question whether Toy’s statement was voluntary was considered, it was only to judge whether it “was sufficiently an act of free will to purge the primary taint of the unlawful invasion.” Id., at 486 (emphasis added).
The Court in Wong Sun, as is customary, emphasized that application of the exclusionary rule on Toy’s behalf protected Fourth Amendment guarantees in two respects: “in terms of deterring lawless conduct by federal officers,” and by “closing the doors of the federal courts to any use of evidence unconstitutionally obtained.” Ibid. These considerations of deterrence and of judicial integrity, by now, have become rather commonplace in the Court’s cases. See, e. g., United States v. Peltier, ante, at 535-538; United States v. Calandra, 414 U. S. 338, 347 (1974); Terry n . Ohio, 392 U. S. 1, 12-13, 28-29 (1968). “The rule is calculated to prevent, not to repair. Its purpose is to deter—to compel respect for the p. 600constitutional guaranty in the only effectively available way—by removing the incentive to disregard it.” Elkins v. United States, 364 U. S. 206, 217 (1960). But “[d]espite its broad deterrent purpose, the exclusionary rule has never been interpreted to proscribe the use of illegally seized evidence in all proceedings or against all persons.” United States v. Calandra, 414 U. S., at 348. See also Michigan v. Tucker, 417 U. S. 433, 446-447 (1974).5
III
The Illinois courts refrained from resolving the question, as apt here as it was in Wong Sun, whether Brown’s statements were obtained by exploitation of the illegality of his arrest. They assumed that the Miranda warnings, by themselves, assured that the statements (verbal acts, as contrasted with physical evidence) were of sufficient free will as to purge the primary taint of the unlawful arrest. Wong Sun, of course, preceded Miranda.
This Court has described the Miranda warnings as a “prophylactic rule,” Michigan v. Payne, 412 U., S. 47, 53 (1973), and as a “procedural safeguard,” Miranda v. Arizona, 384 U. S., at 457, 478, employed to protect Fifth Amendment rights against “the compulsion inherent in custodial surroundings.” Id., at 458. The function of the warnings relates to the Fifth Amendment’s guarantee against coerced self-incrimination, and the exclusion
5 Members of the Court on occasion have indicated disenchantment with the rule. See, e. g., Coolidge v. New Hampshire, 403 U. S. 443, 490 (1971) (Harlan, J., concurring); id., at 492 (Bur ge r , C. J., dissenting in part and concurring in part); id., at 493 (Black, J., concurring and dissenting); id., at 510 (Whi te , J., concurring and dissenting); Bivens n . Six Unknown Federal Narcotics Agents, 403 U. S. 388, 411 (1971) (Bur ge r , C. J., dissenting). Its efficacy has been subject to some dispute. United States v. Calandra, 414 U. S. 338, 348 n. 5 (1974). See Elkins v. United States, 364 U. S. 206, 218 (1960). p. 601of a statement made in the absence of the warnings, it is said, serves to deter the taking of an incriminating statement without first informing the individual of his Fifth Amendment rights.
Although, almost 90 years ago, the Court observed that the Fifth Amendment is in “intimate relation” with the Fourth, Boyd v. United States, 116 U. S. 616, 633 (1886), the Miranda warnings thus far have not been regarded as a means either of remedying or deterring violations of Fourth Amendment rights. Frequently, as here, rights under the two Amendments may appear to coalesce since “the ‘unreasonable searches and seizures’ condemned in the Fourth Amendment are almost always made for the purpose of compelling a man to give evidence against himself, which in criminal cases is condemned in the Fifth Amendment.” Ibid.; see Mapp v. Ohio, 367 U. S., at 646 n. 5. The exclusionary rule, however, when utilized to effectuate the Fourth Amendment, serves interests and policies that are distinct from those it serves under the Fifth. It is directed at all unlawful searches and seizures, and not merely those that happen to produce incriminating material or testimony as fruits. In short, exclusion of a confession made without Miranda warnings might be regarded as necessary to effectuate the Fifth Amendment, but it would not be sufficient fully to protect the Fourth. Miranda warnings, and the exclusion of a confession made without them, do not alone sufficiently deter a Fourth Amendment violation.6
Thus, even if the statements in this case were found to be voluntary under the Fifth Amendment, the Fourth
6 The Miranda warnings in no way inform a person of his Fourth Amendment rights, including his right to be released from unlawful custody following an arrest made without a warrant or without probable cause. p. 602Amendment issue remains. In order for the causal chain, between the illegal arrest and the statements made subsequent thereto, to be broken, Wong Sun requires not merely that the statement meet the Fifth Amendment standard of voluntariness but that it be “sufficiently an act of free will to purge the primary taint.” 371 U. S., at 486. Wong Sun thus mandates consideration of a statement’s admissibility in light of the distinct policies and interests of the Fourth Amendment.
If Miranda warnings, by themselves, were held to attenuate the taint of an unconstitutional arrest, regardless of how wanton and purposeful the Fourth Amendment violation, the effect of the exclusionary rule would be substantially diluted. See Davis v. Mississippi, 394 U. S. 721, 726-727 (1969). Arrests made without warrant or without probable cause, for questioning or “investigation,” would be encouraged by the knowledge that evidence derived therefrom could well be made admissible at trial by the simple expedient of giving Miranda warnings.7 Any incentive to avoid Fourth Amendment violations would be eviscerated by making the warnings, in effect, a “cure-all,” and the constitutional guarantee against unlawful searches and seizures could
7 A great majority of the commentators have taken the same position. See, e. g., Pitler, "The Fruit of the Poisonous Tree” Revisited and Shepardized, 56 Calif. L. Rev. 579, 603-604 (1968); Ruffin, Out on a Limb of the Poisonous Tree: The Tainted Witness, 15 U. C. L. A. L. Rev. 32, 70 (1967); Comment, 1 Fla. St. L. Rev. 533, 539-540 (1973); Note, Admissibility of Confessions Made Subsequent to an Illegal Arrest: Wong Sun v. United States Revisited, 61 J. Crim. L. 207, 212 n. 58 (1970); Comment, Scope of Taint Under the Exclusionary Rule of the Fifth Amendment Privilege Against Self-Incrimination, 114 U. Pa. L. Rev. 570, 574 (1966). But see Comment, Voluntary Incriminating Statements Made Subsequent to an Illegal Arrest—A Proposed Modification of the Exclusionary Rule, 71 Dick. L. Rev. 573, 582-583 (1967). p. 603be said to be reduced to “a form of words.” See Mapp v. Ohio, 367 U. S., at 648.
It is entirely possible, of course, as the State here argues, that persons arrested illegally frequently may decide to confess, as an act of free will unaffected by the initial illegality. But the Miranda warnings, alone and per se, cannot always make the act sufficiently a product of free will to break, for Fourth Amendment purposes, the causal connection between the illegality and the confession. They cannot assure in every case that the Fourth Amendment violation has not been unduly exploited. See Westover v. United States, 384 U. S. 436, 496-497 (1966).
While we therefore reject the per se rule which the Illinois courts appear to have accepted, we also decline to adopt any alternative per se or “but for” rule. The petitioner himself professes not to demand so much. Tr. of Oral Arg. 12, 45, 47. The question whether a confession is the product of a free will under Wong Sun must be answered on the facts of each case. No single fact is dispositive. The workings of the human mind are too complex, and the possibilities of misconduct too diverse, to permit protection of the Fourth Amendment to turn on such a talismanic test. The Miranda warnings are an important factor, to be sure, in determining whether the confession is obtained by exploitation of an illegal arrest. But they are not the only factor to be considered. The temporal proximity of the arrest and the confession,8 the presence of intervening circum-
8 See United States v. Owen, 492 F. 2d 1100, 1107 (CA5), cert, denied, 419 U. S. 965 (1974); Hale v. Henderson, 485 F. 2d 266, 267-269 (CA6 1973), cert, denied, 415 U. S. 930 (1974); United States v. Fallon, 457 F. 2d 15, 19-20 (CAIO 1972); Leonard v. United States, 391 F. 2d 537, 538 (CA9 1968); Pennsylvania ex rel. Craig n . Maroney, 348 F. 2d 22, 29 (CA3 1965). p. 604stances, see Johnson n . Louisiana, 406 U. S. 356, 365 (1972), and, particularly, the purpose and flagrancy of the official misconduct9 are all relevant. See Wong Sun v. United States, 371 U. S., at 491. The voluntariness of the statement is a threshold requirement. Cf. 18 U. S. C. § 3501. And the burden of showing admissibility rests, of course, on the prosecution.10
IV
Although the Illinois courts failed to undertake the inquiry mandated by Wong Sun to evaluate the circumstances of this case in the light of the policy served by the exclusionary rule, the trial resulted in a record of amply sufficient detail and depth from which the determination may be made. We therefore decline the suggestion of the United States, as amicus curiae, see Morales v. New York, 396 U. S. 102 (1969), to remand the case for further factual findings. We conclude that the State failed to sustain the burden of showing that the evidence in question was admissible under Wong Sun.
Brown’s first statement was separated from his illegal arrest by less than two hours, and there was no intervening event of significance whatsoever. In its essentials, his situation is remarkably like that of James Wah Toy in Wong Sun.11 We could hold Brown’s first state-
9 See United States v. Edmons, 432 F. 2d 577 (CA2 1970). See also United States ex rel. Gockley v. Myers, 450 F. 2d 232, 236 (CA3 1971), cert, denied, 404 U. S. 1063 (1972); United States v. Kilgen, 445 F. 2d 287, 289 (CA5 1971).
10 Our approach relies heavily, but not excessively, on the "learning, good sense, fairness and courage of federal trial judges.” Nardone v. United States, 308 U. S. 338, 342 (1939).
11 The situation here is thus in dramatic contrast to that of Wong Sun himself. Wong Sun’s confession, which the Court held admissible, came several days after the illegality, and was preceded p. 605ment admissible only if we overrule Wong Sun. We decline to do so. And the second statement was clearly the result and the fruit of the first.12
The illegality here, moreover, had a quality of purposefulness. The impropriety of the arrest was obvious; awareness of that fact was virtually conceded by the two detectives when they repeatedly acknowledged, in their testimony, that the purpose of their action was “for investigation” or for “questioning.”13 App. 35, 43, 78, 81, 83, 88, 89, 94. The arrest, both in design and in execution, was investigatory. The detectives embarked upon this expedition for evidence in the hope that something might turn up. The manner in which Brown’s arrest was effected gives the appearance of having been calculated to cause surprise, fright, and confusion.
We emphasize that our holding is a limited one. We decide only that the Illinois courts were in error in assuming that the Miranda warnings, by themselves, under Wong Sun always purge the taint of an illegal arrest.
The judgment of the Supreme Court of Illinois is reversed and the case is remanded for further proceedings not inconsistent with this opinion.
It is so ordered.
by a lawful arraignment and a release from custody on his own recognizance. 371 U. S., at 491.
12 The fact that Brown had made one statement, believed by him to be admissible, and his cooperation with the arresting and interrogating officers in the search for Claggett, with his anticipation of leniency, bolstered the pressures for him to give the second, or at least vitiated any incentive on his part to avoid self-incrimina-tion. Cf. Fahy v. Connecticut, 375 U. S. 85 (1963).
13 Detective Lenz had been a member of the Chicago police force for 14 years and a detective for 12 years. App. 6. Detective Nolan had been a detective on the force for 5^ years. Id., at 87.
Pow ell , J., concurring in part 422 U. S.
Mr . Justice White , concurring in the judgment. Insofar as the Court holds (1) that despite Miranda warnings the Fourth and Fourteenth Amendments require the exclusion from evidence of statements obtained as the fruit of an arrest which the arresting officers knew or should have known was without probable cause and unconstitutional, and (2) that the statements obtained in this case were in this category, I am in agreement and therefore concur in the judgment.
Mr . Justice Powell , with whom Mr . Justice Rehn - quis t joins, concurring in part.
I join the Court insofar as it holds that the per se rule adopted by the Illinois Supreme Court for determining the admissibility of petitioner’s two statements inadequately accommodates the diverse interests underlying the Fourth Amendment exclusionary rule. I would, however, remand the case for reconsideration under the general standards articulated in the Court’s opinion and elaborated herein.
A
The issue presented in this case turns on proper application of the policies underlying the Fourth Amendment exclusionary rule, not on the Fifth Amendment or the prophylaxis added to that guarantee by Miranda v. Arizona, 384 U. S. 436 (1966).1 The Court recognized in Wong Sun v. United States, 371 U. S. 471 (1963), that the Fourth Amendment exclusionary rule applies to statements obtained following an illegal arrest just as it does to tangible evidence seized in a similar manner p. 607or obtained pursuant to an otherwise illegal search and seizure. Wong Sun squarely rejected, however, the suggestion that the admissibility of statements so obtained should be governed by a simple “but for” test that would render inadmissible all statements given subsequent to an illegal arrest. Id., at 487-488. In a similar manner, the Court today refrains from according dispositive weight to the single factor of Miranda warnings. I agree with each holding. Neither of the rejected extremes adequately recognizes the competing considerations involved in a determination to exclude evidence after finding that official possession of that evidence was to some degree caused by a violation of the Fourth Amendment.
On this record, I cannot conclude as readily as the Court that admission of the statements here at issue would constitute an effective overruling of Wong Sun. See ante, at 604-605. Although Wong Sun establishes the boundaries within which this case must be decided, the incompleteness of the record leaves me uncertain that it compels the exclusion of petitioner’s statements. The statements at issue in Wong Sun were on the temporal extremes in relation to the illegal arrest. Cf. Collins v. Beto, 348 F. 2d 823, 832, 834-836 (CA5 1965) (Friendly, J., concurring). Toy’s statement was obtained immediately after his pursuit and arrest by six agents. It appears to have been a spontaneous response to a question put to him in the frenzy of that event, and there is no indication that the agents made any attempt to inform him of his right to remain silent. Wong Sun’s statement, by contrast, was not given until after he was arraigned and released on his own recognizance. Wong Sun voluntarily returned to the station a few days after the arrest for questioning. His statement was preceded by an official warning of his right
Powe ll , J., concurring in part 422U.S.
to remain silent and to have counsel if he desired.2 The Court rejected the Government’s assertion that Toy’s statement resulted from an independent act of free will sufficient to purge the consequences of the illegal arrest. Wong Sun’s statement, however, was deemed admissible. Given the circumstances in which Wong Sun’s statement was obtained, the Court concluded that “the connection between the arrest and the statement had ‘become so attenuated as to dissipate the taint.’ ” 371 U. S., at 491.
Like most cases in which the admissibility of statements obtained subsequent to an illegal arrest is contested, this case concerns statements more removed than that of Toy from the time and circumstances of the illegal arrest. Petitioner made his first statement some two hours following his arrest, after he had been given Miranda warnings. The Court is correct in noting that no other significant intervening event altered the relationship established between petitioner and the officers by the illegal arrest. But the Court’s conclusion that admission of this statement could be allowed only by overruling Wong Sun rests either on an overly restrictive interpretation of the attenuation doctrine, to which I cannot subscribe, or on its view that the arrest was made for investigatory purposes, a factual determination that I think more appropriately should have been left for decision in the first instance by the state courts.
B
The Court’s rejection in Wong Sun of a “but for” test, reaffirmed today, ante, at 603-604, recognizes that in some
2 Toy gave a second statement under circumstances similar to those in Wong Sun’s case. The Court did not, however, rule as to the admissibility of this statement, finding instead that it lacked corroboration and was therefore insufficient to support Toy’s conviction. Wong Sun v. United States, 371 U. 8., at 488-491. p. 609circumstances strict adherence to the Fourth Amendment exclusionary rule imposes greater cost on the legitimate demands of law enforcement than can be justified by the rule’s deterrent purposes. The notion of the “dissipation of the taint” attempts to mark the point at which the detrimental consequences of illegal police action become so attenuated that the deterrent effect of the exclusionary rule no longer justifies its cost. Application of the Wong Sun doctrine will generate factspecific cases bearing distinct differences as well as similarities, and the question of attenuation inevitably is largely a matter of degree. The Court today identifies the general factors that the trial court must consider in making this determination. I think it appropriate, however, to attempt to articulate the possible relationships of those factors in particular, broad categories of cases.
All Fourth Amendment violations are, by constitutional definition, “unreasonable.” There are, however, significant practical differences that distinguish among violations, differences that measurably assist in identifying the kinds of cases in which disqualifying the evidence is likely to serve the deterrent purposes of the exclusionary rule. Cf. United States v. Calandra, 414 U. S. 338, 347-348 (1974); Schneckloth v. Bustamonte, 412 U. S. 218, 250 (1973) (Powell , J., concurring). In my view, the point at which the taint can be said to have dissipated should be related, in the absence of other controlling circumstances, to the nature of that taint.
That police have not succeeded in coercing the accused’s confession through willful or negligent misuse of the power of arrest does not remove the fact that they may have tried. The impermissibility of the attempt, and the extent to which such attempts can be deterred by the use of the exclusionary rule, are of primary relevance in determining whether exclusion is an appropriate rem-
Pow ell , J., concurring in part 422 U.S.
edy. The basic purpose of the rule, briefly stated, is to remove possible motivations for illegal arrests. Given this purpose the notion of voluntariness has practical value in deciding whether the rule should apply to statements removed from the immediate circumstances of the illegal arrest. If an illegal arrest merely provides the occasion of initial contact between the police and the accused, and because of time or other intervening factors the accused’s eventual statement is the product of his own reflection and free will, application of the exclusionary rule can serve little purpose: the police normally will not make an illegal arrest in the hope of eventually obtaining such a truly volunteered statement. In a similar manner, the role of the Miranda warnings in the Wong Sun inquiry is indirect. To the extent that they dissipate the psychological pressures of custodial interrogation, Miranda warnings serve to assure that the accused’s decision to make a statement has been relatively unaffected by the preceding illegal arrest. Correspondingly, to the extent that the police perceive Miranda warnings to have this equalizing potential, their motivation to abuse the power of arrest is diminished. Bearing these considerations in mind, and recognizing that the deterrent value of the Fourth Amendment exclusionary rule is limited to certain kinds of police conduct, the following general categories can be identified.
Those most readily identifiable are on the extremes: the flagrantly abusive violation of Fourth Amendment rights, on the one hand, and “technical” Fourth Amendment violations, on the other. In my view, these extremes call for significantly different judicial responses.
I would require the clearest indication of attenuation in cases in which official conduct was flagrantly abusive of Fourth Amendment rights. If, for example, the fac- p. 611tors relied on by the police in determining to make the arrest were so lacking in indicia of probable cause as to render official belief in its existence entirely unreasonable, or if the evidence clearly suggested that the arrest was effectuated as a pretext for collateral objectives, cf. United States n . Robinson, 414 U. S. 218, 237, 238 n. 2 (1973) (Powell , J., concurring), or the physical circumstances of the arrest unnecessarily intrusive on personal privacy, I would consider the equalizing potential of Miranda warnings rarely sufficient to dissipate the taint. In such cases the deterrent value of the exclusionary rule is most likely to be effective, and the corresponding mandate to preserve judicial integrity, see United States v. Peltier, ante, p. 531; Michigan v. Tucker, 417 U. S. 433, 450 n. 25 (1974), most clearly demands that the fruits of official misconduct be denied. I thus would require some demonstrably effective break in the chain of events leading from the illegal arrest to the statement, such as actual consultation with counsel or the accused’s presentation before a magistrate for a determination of probable cause, before the taint can be deemed removed, see Gerstein n . Pugh, 420 U. S. 103 (1975); cf. Johnson v. Louisiana, 406 U. S. 356, 365 (1972); Parker v. North Carolina, 397 U. S. 790, 796 (1970).
At the opposite end of the spectrum lie “technical” violations of Fourth Amendment rights where, for example, officers in good faith arrest an individual in reliance on a warrant later invalidated 3 or pursuant to a statute that subsequently is declared unconstitutional, see United States v. Kilg&n, 445 F. 2d 287 (CA5
31 note that this resolution might have the added benefit of encouraging the police to seek a warrant whenever possible. Cf. Gerstein v. Pugh, 420 U. S. 103, 113 (1975), and sources cited therein.
Pow ell , J., concurring in part 422 IT. S.
1971). As we noted in Michigan n . Tucker, supra, at 447: “The deterrent purpose of the exclusionary rule necessarily assumes that the police have engaged in willful, or at the very least negligent, conduct which has deprived the defendant of some right.” In cases in which this underlying premise is lacking, the deterrence rationale of the exclusionary rule does not obtain, and I can see no legitimate justification for depriving the prosecution of reliable and probative evidence. Thus, with the exception of statements given in the immediate circumstances of the illegal arrest—a constraint I think is imposed by existing exclusionary-rule law—I would not require more than proof that effective Miranda warnings were given and that the ensuing statement was voluntary in the Fifth Amendment sense. Absent aggravating circumstances, I would consider a statement given at the station house after one has been advised of Miranda rights to be sufficiently removed from the immediate circumstances of the illegal arrest to justify its admission at trial.
Between these extremes lies a wide range of situations that defy ready categorization, and I will not attempt to embellish on the factors set forth in the Court’s opinion other than to emphasize that the Wong Sun inquiry always should be conducted with the deterrent purpose of the Fourth Amendment exclusionary rule sharply in focus. See ALI Model Code of Pre-Arraignment Procedure, Art. 150, p. 54 et seq. and Commentary thereon, p. 375 et seq. (Prop. Off. Draft 1975). And, in view of the inevitably fact-specific nature of the inquiry, we must place primary reliance on the “learning, good sense, fairness and courage” of judges who must make the determination in the first instance. Nardone v. United States, 308 U. S. 338, 342 (1939). See ante, at 604 n. 10.
c
On the facts of record as I view them, it is possible that the police may have believed reasonably that there was probable cause for petitioner’s arrest. Although the trial court conducted hearings on petitioner’s motion to suppress and received his testimony and that of the arresting officers, its inquiry focused on determining whether petitioner’s statements were preceded by adequate Miranda warnings and were made voluntarily. The court did not inquire into the possible justification, actual or perceived, for the arrest. Indeed, numerous questions addressed to the circumstances of the arrest elicited the State’s objection, which was sustained. App. 14-15. The Illinois Supreme Court’s consideration of the factual basis for its ruling similarly failed to focus on these relevant issues or to rest in any meaningful sense on the factors set forth in the Court’s opinion today. After determining that the officers lacked probable cause for petitioner’s arrest, the Illinois court concluded simply that examination of the record persuaded it that “the giving of Miranda warnings . . . served to break the causal connection between the illegal arrest and the giving of the statements.” 56 Ill. 2d 312, 317, 307 N. E. 2d 356, 358 (1974).
I am not able to conclude on this record that the officers arrested petitioner solely for the purpose of questioning, ante, at 605; see also ante, at 606 (White , J., concurring in judgment). To be sure, there is evidence suggesting, as the Court notes, an investigatory arrest. The strongest evidence on that point is the inconclusive testimony by the arresting officers themselves. But the evidence is conflicting. Responding to questions as to what they told petitioner upon his arrest, the officers testified he was advised that the arrest was for investigation of murder. Responding to more pointed questions,
Pow ell , J., concurring in part 422U.S.
however, one of the arresting officers stated that he informed petitioner that he was being arrested for murder. See App. 16.4
Moreover, other evidence of record indicates that the police may well have believed that probable cause existed to think that petitioner committed the crime of which he ultimately was convicted. As the opinion of the Illinois Supreme Court reveals, petitioner had been identified as an acquaintance of the deceased, and the police had been told that petitioner was seen in the building where the deceased lived on the day of the murder. 56 Ill. 2d, at 315, 307 N. E. 2d, at 357. It is also plain that the investigation had begun to focus on petitioner. For example, the police had gone to the trouble of obtaining a bullet that petitioner had fired in an unrelated incident for the purpose of comparing it with the bullets that killed the victim. App. 20. The officers also obtained petitioner’s photograph prior to seeking him out, and the circumstances of petitioner’s arrest indicate that their suspicions of him were quite pronounced.
The trial court made no determination as to whether probable cause existed for petitioner’s arrest.5 The Illi-
4 The majority of the statements cited by the Court are the officers’ responses to questions inquiring as to what the officers told petitioner upon arresting him and thus are only indirectly relevant to the issue whether the officers might reasonably have thought they then had sufficient evidence to support a probable-cause determination. Moreover, as noted above, that evidence is contradictory. In only two instances during the trial did the inquiry relate more directly to whether the officers arrested petitioner for questioning. App. 83, 94. The officers’ responses to those questions tend to support the Court’s conclusion. In view of the weight of the contrary evidence, however, I think that the matter should be considered in the first instance by the state courts.
5 Petitioner’s motion to suppress alleged that the police lacked reasonable grounds for believing that he committed a crime. But p. 615nois Supreme Court resolved that issue, but did not consider whether the officers might reasonably, albeit erroneously, have thought that probable cause existed. Rather than decide those matters for the first time at this level, I think it preferable to allow the state courts to reconsider the case under the general guidelines expressed in today’s opinions? I therefore would remand for reconsideration 7 with directions to conduct such further fac-
the testimony at the hearing focused primarily on the issue of the adequacy of the Miranda warnings and the voluntariness of petitioner’s statements. At the close of the hearing the trial court ruled, without elaboration or findings of fact, that the statements were admissible. Id., at 65. Conceivably the trial court thought that probable cause existed to support the arrest. The State argued this point unsuccessfully on appeal. Equally possible, the trial court might have determined that the probable-cause issue was a close one and that, viewing the totality of the circumstances with that fact in mind, the statement should be admitted.
6 The Solicitor General has filed a memorandum as amicus curiae in which he urges the Court to remand the case for further factual hearings, cf. Morales v. New York, 396 U. S. 102 (1969). I concur in the Court’s rejection of this suggestion, agreeing that the record is adequate to allow us to rule on the major issue—whether advice of Miranda rights constitutes a per se attenuation of the taint of an illegal arrest in all cases. I do not agree, however, that the record is adequate for the Court to rule, in addition, that there was insufficient attenuation of taint in this case.
7 Petitioner’s second statement, corroborative of the first, was given more than six hours after his arrest and some five hours after the initial statement. During this time petitioner—cooperating with the police—had made two trips away from the police headquarters in search of Claggett, whom he had identified as his confederate in the murder. This second statement was given to an assistant state’s attorney who again had informed petitioner of his Miranda rights. The Court deems this statement to be the fruit of the first one and thus excludable along with it.
I also would leave the question of admissibility of this statement to the lower Illinois courts. Of course, if the first statement were ruled admissible under the general guidelines articulated in today’s
Pow ell , J., concurring in part 422 U.S.
tual inquiries as may be necessary to resolve the admissibility issue.
opinion, it would follow that the second statement also would be admissible. In any event, the question whether there was sufficient attenuation between the first and second statements to render the second admissible in spite of the inadmissibility of the first presents a factual issue which, like the factual issue underlying the possible admissibility of the first statement, has not been passed on by the state courts.
IVAN ALLEN CO. v. UNITED STATES
CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR
THE FIFTH CIRCUIT
No. 74r-22. Argued April 14r-15, 1975—Decided June 26, 1975
In determining the applicability of § 533 (a) of the Internal Revenue
Code of 1954—which provides a rebuttable presumption that a corporation that has accumulated earnings “beyond the reasonable needs of the business” did so with “the purpose to avoid the income tax with respect to shareholders”—listed and readily marketable securities owned by the corporation and purchased out of its earnings and profits, are to be taken into account, not at their cost to the corporation, but at their net liquidation value. Pp. 624-635. 493 F. 2d 426, affirmed.
Bla ck mu n , J., delivered the opinion of the Court, in which Burg er , C. J., and Bre nn an , Whi te , Mar sha ll , and Reh nq ui st , JJ., joined. Pow el l , J., filed a dissenting opinion, in which Doug - la s and Ste wa rt , JJ., joined, post, p. 635.
Kirk McAlpin argued the cause for petitioner. With him on the briefs were Herschel M. Bloom and Michael C. Russ.
Assistant Attorney General Crampton argued the cause for the United States. With him on the brief were Solicitor General Bork, Stuart A. Smith, and Elmer J. Kelsey .*
Mr . Just ice Blackmu n delivered the opinion of the Court.
Sections 531-537, inclusive, of the Internal Revenue Code of 1954, as amended, 26 U. S. C. §§ 531-537, con-
*Carolyn E. Agger, Walter J. Rockier, and John S. McDaniel, Jr., filed a brief for American Trading and Production Corp, as amicus curiae. p. 618stitute Part I of subchapter G of the Income Tax Subtitle. These sections subject most corporations to an “accumulated earnings tax.” Section 5311 imposes the tax upon the “accumulated taxable income” of every corporation that, as § 532 (a) states,2 is “formed or availed of for the purpose of avoiding the income tax with respect to its shareholders ... by permitting earnings and profits to accumulate instead of being divided or distributed.” And § 533 (a)3 provides that “the fact that the earnings and profits . . . are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the income tax with respect to shareholders, unless the corporation p. 619by the preponderance of the evidence shall prove to the contrary.”4
The issue here is whether, in determining the application of § 533 (a), listed and readily marketable securities owned by the corporation and purchased out of its earnings and profits, are to be taken into account at their cost to the corporation or at their net liquidation value, that is, fair market value less the expenses of, and taxes resulting from, their conversion into cash.
I
The pertinent facts are admitted by the pleadings or are stipulated:
The petitioner, Ivan Allen Company (the taxpayer), is a Georgia corporation incorporated in 1902 and actively engaged in the business of selling office furniture, equipment, and supplies in the metropolitan Atlanta area. It files its federal income tax returns on the accrual basis and for the fiscal year ended June 30.
For its fiscal years 1965 and 1966, the taxpayer paid in due course the federal corporation income taxes shown on its returns as filed. Taxable income so reported was $341,045.82 for 1965 and $629,512.19 for 1966. App. 59, 84. During fiscal 1965 the taxpayer paid dividends consisting of cash in the amount of $48,945.30 and 870 shares
4 In a proceeding before the United States Tax Court, § 534 allows the taxpayer to shift the burden of proof to the Commissioner of Internal Revenue. Section 535 defines “accumulated taxable income” to mean the corporation’s taxable income adjusted as specified; a credit is given for “such part of the earnings and profits for the taxable year as are retained for the reasonable needs of the business,” with a minimum “lifetime” credit of $100,000 ($150,000 for taxable years beginning after December 31, 1974, Pub. L. 94-12, § 304, 89 Stat. 45, 26 U. S. C. § 535 (c)(2) (1970 ed., Supp. IV). Finally, § 537 provides that the term “reasonable needs of the business” includes “the reasonably anticipated needs of the business.” p. 620of Xerox Corporation common that had been carried on its books at a cost of $6,564.34. During fiscal 1966 the taxpayer paid cash dividends of $50,267.49 ; it also declared a 10% stock dividend. Id., at 56. The dividends paid were substantially less than taxable income less federal income taxes for those years.
Throughout fiscal 1965 and 1966, the taxpayer owned various listed and unlisted marketable securities. Prominent among these were listed shares of common stock and listed convertible debentures of Xerox Corporation that, in prior years, had been purchased out of earnings and profits. Specifically, on June 30, 1965, the corporation owned 11,140 shares of Xerox common, with a cost of $116,701 and a then fair market value of $1,573,525, and $30,600 Xerox convertible debentures, with a cost to it of $30,625 and a then fair market value of $48,424. On June 30, 1966, the corporation owned 10,090 shares of Xerox common, with a cost of $102,479 and a then fair market value of $2,479,617, and the same $30,600 convertible debentures, with their cost of $30,625 and a then fair market value of $69,768. Id., at 55.
According to its returns as filed, the taxpayer’s undistributed earnings as of June 30, 1965, and June 30, 1966, were $2,200,184.77 and $2,360,146.52, respectively. Id., at 70, 91. The taxpayer points out that the marketable portfolio assets represented an investment, as measured by cost, of less than 7% of its undistributed earnings and of less than 5% of its total assets. Brief for Petitioner 4.
It is also apparent, however, that the Xerox debentures and common shares had proved to be an extraordinarily profitable investment, although, of course, because these securities continued to be retained, the gains thereon were unrealized for federal income tax purposes. The debentures had increased in fair market value more than 50% over cost by the end of June 1965, p. 621and more than 100% over cost one year later; the common shares had increased in fair market value more than 13 times their cost by June 30, 1965, and more than 24 times their cost by June 30, 1966.
Throughout fiscal 1965 and 1966 the taxpayer’s two major shareholders, Ivan Allen, Sr., and Ivan Allen, Jr., respectively owned 31.20% and 45.46% of the taxpayer’s outstanding voting stock. App. 78, 104.
Following an examination of the taxpayer’s federal income tax returns for fiscal 1965 and 1966, the Commissioner of Internal Revenue determined that the taxpayer had permitted its earnings and profits for each of those years to accumulate beyond the reasonable and reasonably anticipated needs of its business, and that one of the purposes of the accumulation for each year was to avoid income tax with respect to its shareholders. Based upon this determination, the Commissioner assessed against the corporation accumulated earnings taxes of $77,383.98 and $73,131.87 for 1965 and 1966, respectively.
The taxpayer paid these taxes and thereafter timely filed claims for refund. The claims were not allowed, and the taxpayer then instituted this refund suit in the United States District Court for the Northern District of Georgia.
It is agreed that the taxpayer had reasonable business needs for operating capital amounting to $1,198,309 and $1,455,222 at the close of fiscal 1965 and fiscal 1966, respectively. Id., at 56. It is stipulated, in particular, that if the taxpayer’s marketable securities are to be taken into account at cost, its net liquid assets (current assets less current liabilities), at the end of each of those taxable years, and fully available for use in its business, were then exactly equal to its reasonable business needs for operating capital, that is, the above-stated figures of $1,198,309 and $1,455,222. It would follow, accordingly, p. 622that the earnings and profits of the two taxable years had not been permitted to accumulate beyond the taxpayer’s reasonable and reasonably anticipated business needs, within the meaning of § 533 (a), App. 57, and no accumulated earnings taxes were incurred. It is still further stipulated, however, that if the taxpayer’s marketable securities are to be taken into account at fair market value (less the cost of converting them into cash), as of the ends of those fiscal years,5 the taxpayer’s net liquid assets would then be $2,235,029 and $3,152,009, respectively. Id., at 56. From this it would follow that the earnings and profits of the two taxable years had been permitted to accumulate beyond the taxpayer’s reasonable and reasonably anticipated business needs. Then, if those accumulations had been for “the purpose of avoiding the income tax with respect to its shareholders,” under §532 (a), accumulated earnings taxes would be incurred.
The issue, therefore, is clear and precise: whether, for purposes of applying § 533 (a), the taxpayer’s readily marketable securities should be taken into account at cost, as the taxpayer contends, or at net liquidation value, as the Government contends.
The District Court held that the taxpayer’s readily marketable securities were to be taken into account at cost. Accordingly, it entered judgment for the petitioner-taxpayer. 349 F. Supp. 1075 (1972). The court observed :
“Corporate taxpayers should not be penalized for
5 It is stipulated that the cost of converting the taxpayer’s marketable securities into cash would have been the sum of a maximum of 6% of the fair market value of the securities (payable as a brokerage commission) and a maximum of 25% of such amount of the fair market value as exceeds the sum of the brokerage commission and the cost of the securities (payable as capital gains taxes). App. 55.
wise investments; they should be allowed to maximize their capital gains tax advantages in accordance with internal business policies and stock market conditions rather than being forced to sell securities which may have a high value on an arbitrarily selected date merely because the unrealized fair market value of the securities on that date would trigger the accumulated earnings tax.” Id., at 1077. (Footnote omitted.)
The United States Court of Appeals for the Fifth Circuit reversed. 493 F. 2d 426 (1974). It observed:
“[T]he securities involved in the case at bar are of such a highly liquid character as to be readily available for business needs that might arise. Thus the appreciated value of these securities should be taken into account when determining whether the corporation has accumulated profits in excess of reasonable business needs.
“This decision does not force the corporation to liquidate these securities at any time when a sale would be financially unwise, but only compels the corporation to comply with the proscriptions of the Code and refrain from accumulating excessive earnings and profits.” Id., at 428. The case was remanded, as the parties had agreed, App. 57-58, “for the additional factual determination [under § 532 (a)] of whether one purpose for the accumulation was to avoid income tax on behalf of the shareholders.” 493 F. 2d, at 428.
Because this conclusion was claimed by the taxpayer to conflict in principle with American Trading & Production Corp. v. United States, 362 F. Supp. 801 (Md. 1972), aff’d without published opinion, 474 F. 2d 1341 (CA4 p. 6241973),6 and because of the importance of the issue in the administration of the accumulated earnings tax, we granted certiorari. 419 U. S. 1067 (1974).
II
Under our system of income taxation, corporate earnings are subject to tax at two levels. First, there is the tax imposed upon the income of the corporation. Second, when the corporation, by way of a dividend, distributes its earnings to its shareholders, the distribution is subject to the tax imposed upon the income of the shareholders. Because of the disparity between the corporate tax rates and the higher gradations of the rates on individuals,7 a corporation may be utilized to reduce significantly its shareholders’ overall tax liability by accumulating earnings beyond the reasonable needs of the business. Without some method to force the distribution of unneeded corporate earnings, a controlling shareholder would be able to postpone the full impact of income taxes on his share of the corporation’s earnings in excess of its needs. See B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders fl 8.01 (3d ed. 1971); B. Wolfman, Federal Income Taxation of Business Enterprise 864 (1971).
In order to foreclose this possibility of using the corporation as a means of avoiding the income tax on dividends to the shareholders, every Revenue Act since the adoption of the Sixteenth Amendment in 1913 has imposed a tax
6 American Trading and Production Corporation, pursuant to our Rule 42, was granted permission to file a brief as amicus curiae in the present case. It asserts that no conflict exists between the decisions in this case and in its own case.
7 The income tax rates for a corporation are 22% of the first $25,000 of taxable income and 48% of the excess over $25,000. § 11 of the 1954 Code, 26 U. S. C. § 11. The graduated rates for an individual taxpayer range from 14% to 70%. § 1, 26 U. S. C. § 1. p. 625upon unnecessary accumulations of corporate earnings effected for the purpose of insulating shareholders.8
The Court has acknowledged the obvious purpose of the accumulation provisions of the successive Acts:
“As the theory of the revenue acts has been to tax corporate profits to the corporation, and their receipt
8 The accumulated earnings tax originated in § II A, Subdivision 2, of the Tariff Act of October 3, 1913, 38 Stat. 166. This imposed a tax on the shareholders of a corporation “formed or fraudulently availed of for the purpose of preventing the imposition of such tax through the medium of permitting such gains and profits to accumulate instead of being divided or distributed.” Accumulations “beyond the reasonable needs of the business shall be prima facie evidence of a fraudulent purpose to escape such tax.” Id., at 167. The same provision appeared as § 3 of the Revenue Act of 1916, 39 Stat. 758, and again as § 220 of the Revenue Act of 1918, 40 Stat. 1072 (1919), except that in the 1918 Act the word “fraudulently” was deleted. This change was effected inasmuch as the Senate felt that the former phraseology “has proved to be of little value, because it was necessary to its application that intended fraud on the revenue be established in each case.” S. Rep. No. 617, 65th Cong., 3d Sess., 5 (1918).
This pattern of tax on the shareholders was changed with the Revenue Act of 1921, § 220, 42 Stat. 247. The incidence of the tax was shifted from the shareholders to the corporation itself. Judge Learned Hand opined that the change was due to doubts “as to the validity of taxing income which the taxpayers had never received, and in 1921 it was thought safer to tax the company itself.” United Business Corp. v. Commissioner, 62 F. 2d 754, 756 (CA2), cert, denied, 290 U. S. 635 (1933).
Although the statutory language has varied somewhat from time to time, the income tax law, since the change effected by the Revenue Act of 1921, consistently has imposed the tax on the corporation, rather than upon the shareholders. Revenue Act of 1924, § 220, 43 Stat. 277; Revenue Act of 1926, § 220, 44 Stat. 34; Revenue Act of 1928, § 104, 45 Stat. 814; Revenue Act of 1932, § 104, 47 Stat. 195; Revenue Act of 1934, § 102, 48 Stat. 702; Revenue Act of 1936, § 102, 49 Stat. 1676; Revenue Act of 1938, § 102, 52 Stat. 483; Internal Revenue Code of 1939, § 102.
only when distributed to the stockholders, the purpose of the legislation is to compel the company to distribute any profits not needed for the conduct of its business so that, when so distributed, individual stockholders will become liable not only for normal but for surtax on the dividends received.” Helvering v. Chicago Stock Yards Co., 318 U. S. 693, 699 (1943). This was reaffirmed in United States v. Donruss Co., 393 U. S. 297, 303 (1969). It is to be noted that the focus and impositions of the accumulated earnings tax are upon “accumulated taxable income,” § 531. This is defined in § 535 (a) to mean the corporation’s “taxable income,” as adjusted. The adjustments consist of the various items described in § 535 (b), including federal income tax, the deduction for dividends paid, defined in § 561, and the accumulated earnings credit defined in § 535 (c). The adjustments prescribed by §§ 535 (a) and (b) are designed generally to assure that a corporation’s “accumulated taxable income” reflects more accurately than “taxable income” the amount actually available to the corporation for business purposes. This explains the deductions for dividends paid and for federal income taxes; neither of these enters into the computation of taxable income. Obviously, dividends paid and federal income taxes deplete corporate resources and must be recognized if the corporation’s economic condition is to be properly perceived. Conversely, § 535 (b) (3) disallows, for example, the deduction, available to a corporation for income tax purposes under § 243, on account of dividends received; dividends received are freely available for use in the corporation’s business.
The purport of the accumulated earnings tax structure established by §§ 531-537, therefore, is to determine the p. 627corporation’s true economic condition before its liability for tax upon “accumulated taxable income” is determined. The tax, although a penalty and therefore to be strictly construed, Commissioner v. Acker, 361 U. S. 87, 91 (1959), is directed at economic reality.
It is important to emphasize that we are concerned here with a tax on “accumulated taxable income,” § 531, and that the tax attaches only when a corporation has permitted “earnings and profits to accumulate instead of being divided or distributed,” § 532 (a). What is essential is that there be “income” and “earnings and profits.” This at once eliminates, from the measure of the tax itself, any unrealized appreciation in the value of the taxpayer’s portfolio securities over cost, for any such unrealized appreciation does not enter into the computation of the corporation’s “income” and “earnings and profits.”
The corporation’s readily marketable portfolio securities and their unrealized appreciation, nonetheless, are of profound importance in making the entirely discrete determination whether the corporation has permitted what, concededly, are earnings and profits to accumulate beyond its reasonable business needs. If the securities, as here, are readily available as liquid assets, then the recognized earnings and profits that have been accumulated may well have been unnecessarily accumulated, so far as the reasonable needs of the business are concerned. On the other hand, if those portfolio securities are not liquid and are not readily available for the needs of the business, the accumulation of earnings and profits may be viewed in a different light. Upon this analysis, not only is such accumulation as has taken place important, but the liquidity otherwise available to the corporation is highly significant. In any event—and we repeat—the tax is directed at the accumulated taxable income and p. 628at earnings and profits. The tax itself is not directed at the unrealized appreciation of the liquid assets in the securities portfolio. The latter becomes important only in measuring reasonableness of accumulation of the earnings and profits that otherwise independently exist. What we look at, then, in order to determine its reasonableness or unreasonableness, in the light of the needs of the business, is any failure on the part of the corporation to distribute the earnings and profits it has.
Accumulation beyond the reasonable needs of the business, by the language of § 533 (a), is “determinative of the purpose” to avoid tax with respect to shareholders unless the corporation proves the contrary by a preponderance of the evidence. The burden of proof, thus, is on the taxpayer. A rebuttable presumption is statutorily imposed. To be sure, we deal here, in a sense, with a state of mind. But it has been said that the statute, without the support of the presumption, would “be practically unenforceable . . . .” United Business Corp. n . Commissioner, 62 F. 2d 754, 755 (CA2), cert, denied, 290 U. S. 635 (1933). What is required, then, is a comparison of accumulated earnings and profits with “the reasonable needs of the business.” Business needs are critical. And need, plainly, to use mathematical terminology, is a function of a corporation’s liquidity, that is, the amount of idle current assets at its disposal. The question, therefore, is not how much capital of all sorts, but how much in the way of quick or liquid assets, it is reasonable to keep on hand for the business. United Block Co. v. Helvering, 123 F. 2d 704, 705 (CA2 1941), cert, denied, 315 U. S. 812 (1942); Smoot Sand & Gravel Corp. v. Commissioner, 274 F. 2d 495, 501 (CA4), cert, denied, 362 U. S. 976 (1960) (liquid assets provide “a strong indication” of the purpose of the accumulation); Electric Regulator p. 629Corp. v. Commissioner, 336 F. 2d 339, 344 (CA2 1964); Novelart Mjg. Co. v. Commissioner, 52 T. C. 794, 806 (1969), aff’d, 434 F. 2d 1011 (CA6 1970), cert, denied, 403 U. S. 918 (1971); John P. Scripps Newspapers v. Commissioner, 44 T. C. 453, 467 (1965).9
The taxpayer itself recognizes, and accepts, the liquidity concept as a basic factor, for it “has agreed that the full amount of its realized earnings invested in its liquid assets—their cost—should be taken into account in determining the applicability of Section 533 (a).” Brief for Petitioner 15. It concedes that if this were not so, “the tax could be avoided by any form of investment of earnings and profits.” Reply Brief for Petitioner 5. But the taxpayer would stop at the point of cost and, when it does so, is compelled to compare earnings and profits— not the amount of readily available liquid assets, net— with reasonable business needs.
We disagree with the taxpayer and conclude that cost is not the stopping point; that the application of the accumulated earnings tax, in a given case, may well depend on whether the corporation has available readily marketable portfolio securities; and that the proper measure of those securities, for purposes of the tax, is their net realizable value. Cost of the marketable securities on the assets side of the corporation’s balance sheet would appear to be largely an irrelevant gauge of the taxpayer’s true financial condition.10 Certainly, a
9 In this case we are concerned only with readily marketable securities. We express no view with respect to items of a different kind, such as inventory or accounts receivable.
10 “The tax should be administered with its purpose in mind at all times, i. e., to prevent accumulations of income by the corporation for the purpose of avoiding the income tax ordinarily incident to the shareholders. It is not intended to serve as an obstacle to sound profit-oriented corporate management. The ultimate goal p. 630lender would not evaluate a potential borrower’s marketable securities at cost. Realistic financial condition is the focus of the lender’s inquiry. It also must be the focus of the Commissioner’s inquiry in determining the applicability of the accumulated earnings tax.11
This taxpayer’s securities, being liquid and readily marketable, clearly were available for the business needs of the corporation, and their fair market value, net, was such that, according to the stipulation, the taxpayer’s undistributed earnings and profits for the two fiscal years in question were permitted to accumulate beyond the reasonable and reasonably anticipated needs of the business.
Ill
Bearing directly upon the issue before us is Helvering v. National Grocery Co., 304 U. S. 282 (1938). There the fact situation was the reverse of the present case inasmuch as that taxpayer corporation had unrealized losses in the value of marketable securities it was continuing to hold. After the Court upheld the accumulated earnings tax against constitutional attack, id., at
must be to administer the tax fairly, in light of the total economic reality of the corporation. Valuing liquid assets at cost invariably produces a poor and inaccurate picture of the corporate financial position. Adjusted fair market value may have shortcomings of its own, but it does, undeniably, come much closer to furthering the intent of the accumulated earnings tax.” Note, Accumulated Earnings Tax: Should Marketable Securities be Valued at Cost or at Fair Market Value in Determining the Reasonableness of Further Accumulations of Income?, 40 Brooklyn L. Rev. 192, 209-210 (1973).
11 We see little force in any observation that our emphasis on liquid assets means that a corporate taxpayer may avoid the accumulated earnings tax by merely investing in nonliquid assets. If such a step, in a given case, amounted to willful evasion of the accumulated earnings tax, it would be subject to criminal penalties. See, e. g., § 7201 of the 1954 Code, 26 U. S. C. § 7201. p. 631286-290, it observed: “Depreciation in any of the assets is evidence to be considered by the Commissioner and the Board [of Tax Appeals] in determining the issue of fact whether the accumulation of profits was in excess of the reasonable needs of the business.” Id., at 291. It went on to hold, however, that such depreciation “does not, as matter of law, preclude a finding that the accumulation of the year’s profits was in excess of the reasonable needs of the business.” Ibid. Indeed, the Court held that the evidence supported the Board’s finding that the accumulation of surplus by the taxpayer was to enable its sole shareholder to escape surtaxes. It focused on bonds and stocks held by the corporation, described them as in no way related to the business, and concluded that “there was no need of accumulating any part of the year’s earnings for the purpose of financing the business.” Id., at 291-292. That language forecloses the present taxpayer’s case.
The precedent of National Grocery has been applied in accumulated earnings tax cases, with courts taking into account the fair market value of liquid, appreciated securities. Battelstein Investment Co. v. United States, 442 F. 2d 87, 89 -(CA5 1971); Cheyenne Newspapers, Inc. v. Commissioner, 494 F. 2d 429, 434-435 (CAIO 1974); Henry Van Hummell, Inc. v. Commissioner, 23 T. C. M. 1765, 1779 (1964), aff’d, 364 F. 2d 746 (CAIO 1966), cert, denied, 386 U. S. 956 (1967); Golconda Mining Corp. v. Commissioner, 58 T. C. 139, supplemental opinion, 58 T. C. 736, 737-739 (1972), rev’d on other grounds, 507 F. 2d 594 (CA9 1974); Ready Paving & Constr. Co. v. Commissioner, 61 T. C. 826, 840-841 (1974). But see Harry A. Koch Co. v. Vinal, 228 F. Supp. 782, 784 (Neb. 1964).
American Trading & Production Corp. v. United States, 362 F. Supp. 801 (Md. 1972), aff’d without pub- p. 632lished opinion, 474 F. 2d 1341 (CA4 1973), which the taxpayer continues to assert is in conflict with the present case, deserves mention. The taxpayer there had accumulated earnings and profits of something less than $10 million. Its anticipated business needs were about $12 million. But it owned stocks, primarily oil shares, having a total cost of $5,593,319 and an aggregate current market value in excess of $100 million. The District Court excluded these stocks in making its determination whether earnings had accumulated in excess of reasonable business needs. It did so on several grounds: that the shares constituted “original capital,” a term the court used in the sense that the stocks “were properly held and retained as an integral part of [the taxpayer’s] business and were utilized ... as a base for borrowings for the needs of other parts of its business,” 362 F. Supp., at 810; that the statute was not intended to require the conversion of assets of that kind into cash in order to meet business needs, even though that capital “has explosively increased in value,” id., at 808; and that “there was substantial evidence” that the stocks “were not readily saleable,” id., at 809.
Whatever may be the merit or demerit of the other grounds asserted by the District Court in American Trading—and we express no view thereon—we are satisfied that the court’s determination as to the absence of ready salability, under all the circumstances, provides a sufficient point of distinction of that case from this one, so that it provides meager, if any, contrary precedent of substance to our conclusion here.
IV
The arguments advanced by the taxpayer do not persuade us: p. 633unrealized appreciation of portfolio securities does not enter into the determination of “earnings and profits,” within the meaning of § 533 (a). As noted above, we agree. The Government does not contend otherwise. It does not follow, however, that unrealized appreciation is never to be taken into account for purposes of the accumulated earnings tax.
As has been pointed out, the tax is imposed only upon accumulated taxable income, and this is defined to mean taxable income as adjusted by factors that have been described. The question is not whether unrealized appreciation enters into the determination of earnings and profits, which it does not, but whether the accumulated taxable income, in the determination of which earnings and profits have entered, justifiably may be retained rather than distributed as dividends. The tax focuses, therefore, on current income and its retention or distribution. If the corporation has freely available liquid assets in excess of its reasonable business needs, then accumulation of taxable income may be unreasonable and the tax may attach. Utilizable availability of the portfolio assets is measured realistically only at net realizable value. The fact that this value is not included in earnings and profits does not foreclose its being considered in determining whether the corporation is subject to the accumulated earnings tax.
2. We see nothing in the “realization of income” concept of Eisner v. Macomber, 252 U. S. 189 (1920), that has significance for the issue presently under consideration. There the Court held that a dividend of common shares issued by a corporation having only common outstanding was not includable in the shareholder’s gross income for income tax purposes. The decision may have prompted the shift, noted above and effected by the Revenue Act of 1921, of the incidence of the accumulated p. 634earnings tax from the shareholders to the corporation. The case also emphasizes the realization of income with respect to a tax on the shareholder. We note again, however, that the accumulated earnings tax is not on unrealized appreciation of the portfolio securities. It rests upon, and only upon, the corporation’s current taxable income adjusted to constitute “accumulated taxable income.”
3. The taxpayer also argues that the effect of the Court of Appeals decision is to force the taxpayer to convert its appreciated assets in order to meet its business needs. It suggests that management should be entitled to finance business needs without resorting to unrealized appreciation. The argument, plainly, goes too far. On the taxpayer’s own theory that marketable securities may be taken into account at their cost, a situation easily may be imagined where some conversion into cash becomes necessary, if the corporation is to avoid the accumulated earnings tax.
That our decision does not interfere with corporate management’s exercise of sound business judgment, and that it does not amount to a dictation to management as to when appreciated assets are to be liquidated, was aptly answered by the Court of Appeals:
“This decision does not force the corporation to liquidate these securities at any time when a sale would be financially unwise, but only compels the corporation to comply with the proscriptions of the Code and refrain from accumulating excessive earnings and profits. That taxpayer, as a consequence of its own sound judgment in making profitable investments, must sell, exchange or distribute to the shareholders assets in order to avoid an excessive accumulation of earnings and thus comply with the Code’s
requirements is no justification for precluding its application.” 493 F. 2d, at 428. We might add that the existence of the Code’s provisions for the accumulated earnings tax, of course, will affect management’s decision. So, too, does the very existence of the corporate income tax itself. In this respect, the one is no more offensive than the other. Astute management in these tax-conscious days is not that helpless, and shrinkage, upon liquidation, of one-fourth of the appreciation hardly equates with loss. Such business decision as is necessitated was expressly intended by the Congress. All that is required is the disgorging, at the most, of the taxable year’s “accumulated taxable income.”
4. It is no answer to suggest that our decision here may conflict with standard accounting practice. The Court has not hesitated to apply congressional policy underlying a revenue statute even when it does conflict with an established accounting practice. See, e. g., Schlude v. Commissioner, 372 U. S. 128 (1963); American Automobile Assn. v. United States, 367 U. S. 687, 692-694 (1961). It is of some interest that the taxpayer itself, for the tax years under consideration, reflected the market value as well as the cost of its marketable securities on its balance sheets. App. 112, 118. This appears to be in line with presently accepted practice. See R. Kester, Advanced Accounting 117-118, 122-124 (4th ed. 1946).
The judgment of the Court of Appeals is affirmed.
It is so ordered.
Mr . Justice Powell , with whom Mr . Just ice Doug - las and Mr . Justic e Stew art join, dissenting.
The Court’s decision departs significantly from the relevant statutory language, creates a rule of additional
Pow el l , J., dissenting 422 U.S.
tax liability that places business management in a perilous position, and vests in the Internal Revenue Service an inappropriate degree of discretion in administering a punitive statute. I therefore dissent.
I
Petitioner, a corporation with 34 stockholders, is engaged in selling office supplies and equipment. In the late 1950’s, because petitioner was a retail outlet for equipment of the Xerox Corp., it invested $147,- 000 of its earnings and profits in securities of Xerox. The market value of that investment increased substantially over the years, and by the end of petitioner’s 1965 and 1966 tax years the unrealized market appreciation1 of those securities approximated $1,475,000 and $2,416,000 respectively.2 For the purpose of determining the applicability of the additional penalty tax liability under 26 U. S. C. § 531, the Commissioner valued these securities at their year-end market price. He thereupon assessed the tax here at issue.
The question is one of statutory construction: In determining whether a corporation has accumulated earnings and profits in excess of reasonable business needs within the meaning of 26 U. S. C. § 533 (a), are assets purchased with earnings and profits to be valued at the amount invested in them—their cost—or at their market p. 637price,3 which reflects both cost and unrealized appreciation? The question has not heretofore been decided by this Court and has been considered infrequently by other federal courts.
II
I address first the statutory language, which in my view is controlling. Section 531 imposes a tax “[i]n addition to other taxes imposed by this chapter ... on the accumulated taxable income ... of every corporation” identified by § 532. Section 532 makes the § 531 tax applicable to every corporation “formed or availed of for the purpose of avoiding the income tax with respect to its shareholders ... by permitting earnings and profits to accumulate instead of being divided or distributed.” If “the earnings and profits of a corporation are permitted to accumulate” beyond its reasonable needs, § 533 establishes a rebuttable presumption that the corporation is one “formed or availed of for the purpose of avoiding the income tax” and that it is therefore liable for the § 531 tax.
The central element of this statutory scheme is the unreasonable accumulation of earnings and profits beyond the corporation’s reasonable needs. It is stipulated in this case that there is no unreasonable accumulation and no additional tax unless the unrealized appreciation of the Xerox securities is added to petitioner’s actual accumulated earnings and profits (i. e., to its earned sur-
3 The Court refers to net liquidation value, which reflects the asset’s current market price less the costs and expenses attendant to its liquidation. The Court thus seeks to identify the sum that would be made available by a hypothetical sale of the asset in question, although nothing in the statute requires such a liquidation. For the purpose of discussion, I will refer simply to market value or market price.
Pow el l , J., dissenting 422U.S.
plus account) .4 Under normal concepts of tax law and accounting the Government’s position is therefore untenable on its face. Unrealized appreciation of assets is not considered in computing ordinary corporate or individual taxable income. Indeed, sound accounting practice requires that assets be recorded and carried at cost,5 and this requirement is enforced with respect to filings with the Securities and Exchange Commission (SEC). Similarly, if assets of a corporation are distributed to shareholders “in kind,” the company is credited for a dividend payment only on the basis of the cost of those assets, not their appreciated value.
In view of this unanimity of law and practice, what theory is devised by the Government and the Court today as justification for a different rule for this penalty tax? I look to the Court’s opinion for the answer. It is conceded that “unrealized appreciation does not enter into the computation of the corporation’s . . . [accumulated] ‘earnings and profits.’ ” Ante, at 627. Neverthe-
4 There may be some ambiguity in the critical language stating the Court’s theory of the case, ante, at 626, as to whether it intends the term “accumulated” to refer only to earnings and profits accumulated in the tax year in question or to all accumulated and undistributed earnings as shown by the corporation’s earned surplus account. I assume the Court refers to the latter, as the statutory language and purpose contemplate consideration of the total accumulation in determining whether the retention of earnings and profits of a given year has been in excess of the amount justified by reasonable business needs.
5 It is not unusual, of course, for a corporation also to show parenthetically on its balance sheet, or in a footnote thereto, the market price of assets when that figure can be ascertained readily. But unrealized appreciated value, whether based on market price or an appraisal of the asset, is normally not included in the sum of a corporation’s assets or in its surplus account on the liability side of its balance sheet. p. 639617 Powe ll , J., dissenting
less, the Court holds that such appreciation “becomes important” and must be taken into account “in measuring [the] reasonableness” of such accumulation. Ante, at 628. In short, the Court construes the statute to mean that although unrealized appreciation is not includable in computing earnings and profits, it is includable in determining whether earnings and profits have been accumulated unreasonably.
The statute provides no basis whatever for this distinction. According to its own terms, selected with full knowledge of accepted tax and accounting principles, the penalty tax applies only if there is an unreasonable accumulation of earnings and profits; the statute contains no reference to the addition of unrealized appreciation to the accumulated earnings and profits which constitute the only basis for imposing the tax. Nor does the history or purpose of the statute support the “add on” of an unrealized increment of value conceded by the Court to be neither earnings nor profits. By authorizing this “add on,” the Court’s decision effectively converts the tax on excessive accumulation of earnings and profits to a tax on the retention of certain assets that appreciate in value. Although current accumulated taxable income remains the measure of the tax, its application in many cases will be controlled simply by the existence of unrealized appreciation in the value of these assets.
The purpose of the statute, as the Court states, is “to force the distribution of unneeded corporate earnings.” Ante, at 624. Such a distribution is accomplished by the payment of dividends, which normally are declared and paid only out of current earnings or earned surplus, determined in accordance with sound accounting practice. Absent authorization in a statute or corporate charter, corporate directors who pay dividends from unrealized p. 640appreciation risk personal liability at the suit of stockholders or injured creditors.6
Ill
The plain language of the Code resolves this case for me. But even if the statute could be thought ambigu-
6 See 11 W. Fletcher, Cyclopedia of the Law of Private Corporations §§5329, 5329.1, 5335, 5335.1 (1971). Some States have statutes expressly prohibiting recognition of unrealized appreciation as a source upon which a corporation can rely in determining the amount of a dividend that legally can be paid. E. g., Cal. Corp. Code §§ 1502, 1505 (1955); Ind. Ann. Stat. § 23-1-2-15 (a) (1972). Other States have statutes allowing limited recognition of unrealized appreciation. E. g., Minn. Stat. §301.22 (1) (1974) (a corporation may take into account appreciation of “securities having a readily ascertainable market value”; otherwise, unrealized appreciation may not be counted in computing earnings available for dividends); Ohio Rev. Code Ann. § 1701.33 (A) (Supp. 1974) (allows only share dividends to be paid from unrealized appreciation). The decisional law of States lacking precise statutory guidance generally prohibits reliance on unrealized appreciation. 11 W. Fletcher, supra, § 5335.1; H. Henn, Handbook of the Law of Corporations and Other Business Enterprises § 320, pp. 652-653 (1970).
Georgia’s law follows the Model Business Corporation Act, allowing payment of cash or property dividends only out of earned surplus or current earnings. Ga. Code Ann. § 22-511 (a) (1) (1970); Model Bus. Corp. Act § 45 (a). Share dividends may be paid out of capital surplus on certain conditions, Ga. Code Ann. §22-511 (a)(4); Model Bus. Corp. Act § 45(d), and stricter conditions govern the declaration of cash or property dividends out of capital surplus. Ga. Code Ann. §22-512; Model Bus. Corp. Act §46. Commentators have suggested that under the Model Act a corporation could revalue its assets, creating capital surplus out of the unrealized appreciation, and then pay dividends out of the capital surplus, but that course of action is considered quite risky for the directors. Bugge, Unrealized Appreciation as a Source of Shareholder Distributions Under the Wisconsin Business Corporation Law, 1964 Wis. L. Rev. 292, 300-304, 312-313; Hackney, The Financial Provisions of the Model Business Corporation Act, 70 Harv. L. Rev. p. 641ous on the point, the tax is, as the Court concedes, a “penalty and therefore [must] be strictly construed ... Ante, at 627. See Commissioner v. Acker, 361 U. S. 87, 91 (1959). This means, at a minimum, that doubts and ambiguities must be resolved in favor of a fair and equitable construction that is as free from the hazards of uncertainty as the statutory language and purpose will allow. It seems to me that the Court’s opinion ignores the meaning of this canon of construction. Rather than construe the statute narrowly, today’s decision extends the presumptive reach of this tax beyond the language of the Code and creates a number of perplexing uncertainties.
Businesses normally are conducted, and management decisions made, on the basis of financial information that is maintained in accordance with sound accounting practice. The most elementary principle of accounting practice is that assets are recorded at cost. This is true with respect to the computation of earnings and profits, payment of ordinary corporate taxes, determination of dividend policy, and reporting to stockholders, the SEC, and other regulatory agencies. Corporate books and records are audited only on that basis. Whatever may be said for the Court’s view of the “unreality” of adhering to the principles of sound accounting practice, ante, at 629-630, those principles are the best system yet devised for guiding management, informing shareholders, and determining tax liability. They have the not inconsiderable virtues of consistency, regularity, and certainty—virtues that also assure fairness and reasonable
1357, 1377-1381 (1957). Under Georgia law, Ga. Code Ann. §22— 715 (c), as under the Model Act § 48, a director is not liable for an illegal dividend distribution if in computing the amount available for dividends he considers the corporate assets at their “book value.”
Pow ell , J., dissenting 422 U.S.
predictability in the Commissioner’s administration of this penalty tax.
The Court today abandons accounting principles confirmed by the wisdom of business experience and announces a new rule with far-reaching consequences. In my view, this rule will create uncertainty and open wide possibilities for unfairness.
A
Both taxpayers and the Government know what is meant by “cost basis,” and a corporation’s earned surplus account, which reflects accumulated earnings and profits from which dividends normally are paid, is an established accounting fact. There is no comparable certainty or dependability in the rule devised by the Court:
“Cost of the marketable securities on the assets side of the corporation’s balance sheet would appear to be largely an irrelevant gauge of the taxpayer’s true financial condition. . . . Realistic financial condition is the focus ... of the Commissioner’s inquiry in determining the applicability of the accumulated earnings tax.” Ante, at 629-630 (emphasis added).
In this case, involving marketable securities, the computation of the true value for purposes of the tax appears at first blush to present no serious problem of uncertainty. The Court simply equates market price at the end of the tax year with true value, and adds the resulting excess over cost to the book value of the securities. Apart from the questionable assumption that market quotations represent the true value of a retained common stock, the Court’s new formulation poses perplexing definitional questions for management.
An initial uncertainty results from the Court’s ambiguous use of the term “securities.” As defined in the p. 643Securities Act of 1933 and the Securities Exchange Act of 1934, the term is quite comprehensive.7 Even so, its meaning is not always self-evident, as can be seen by examining some of the extensive litigation on this question. See, e. g., 1050 Tenants Corp. v. Jakobson, 503 F. 2d 1375 (CA2 1974); SEC v. Glenn W. Turner Enterprises, Inc., 474 F. 2d 476 (CA9), cert, denied, 414 U. S. 821 (1973); Lehigh Valley Trust Co. v. Central National Bank of Jacksonville, 409 F. 2d 989 (CA5 1969).
In addition, uncertainties will arise in ascertaining whether the asset is sufficiently “readily marketable” to satisfy the Court’s test. The Court attaches significance to whether the security is “listed” on a stock exchange. It is indeed true that the great majority of common stocks listed on the New York Stock Exchange are readily marketable, unless the number of shares to be sold is too large for the market to absorb. The same cannot be said, however, of all bonds listed on that Exchange. Moreover, there are other exchanges on which securities are listed and traded: the American Stock Exchange, over the counter, and scores of local exchanges. While many securities traded on these exchanges may be “readily marketable,” perhaps the majority could not fairly be so characterized. In countless situations corporate management will be unable to determine, short of attempting to sell the security, whether it is “readily marketable” or not.
7 Among other things, the term “security” includes stocks, bonds, debentures, certificates of interest or participation in profit-sharing agreements, collateral trust certificates, investment contracts, votingtrust certificates, fractional undivided interests in oil, gas, or other mineral rights, or “in general, any interest or instrument commonly known as a 'security ....’” 48 Stat. 74, as amended, 15 U. S. C. § 77b (1); 48 Stat. 882, as amended, 15 U. S. C. § 78c (10). See United Housing Foundation, Inc. v. Forman, 421 U. S. 837 (1975).
B
The uncertainty engendered by today’s opinion will not be limited to its undifferentiated treatment of marketable securities. A more fundamental question arising from the rationale of the Court’s decision is whether the test of “true” or “realistic” financial condition will be applied to other assets. Nothing in the relevant statutory provisions suggests a distinction between securities and other assets, or even between assets with varying degrees of marketability. The Court nevertheless appears to read into the statutes a distinction based on “liquidity,” at various points referring interchangeably to “readily marketable securities,” “current assets,” and “quick or liquid assets.” Ante, at 622, 628. Although the Court’s holding is limited in this case to readily marketable securities, see ante, at 629 n. 9, its rationale is not so easily contained.
The Court states categorically that the “focus” of the Commissioner’s inquiry, in determining the application of this tax, must be on what it calls true or realistic financial condition. Ante, at 629-630. In view of this postulation, and the absence of any distinction in the statute among types of assets, is the Commissioner now free to include in his computation the unrealized appreciation of all corporate assets? Once cost basis is abandoned, and “realistic” value becomes the standard, the uncertainties confronting prudent management in many cases will be profoundly disquieting. To be sure, read narrowly, the Court’s decision applies only to readily marketable securities, with emphasis on “liquidity.” But this is another relative term, depending on the nature of the asset and the uncertainties of market conditions at the time.
The potential sweep of the Court’s decision is forecast by the response of Government counsel to questions p. 645about unrealized appreciation on real estate. At one point counsel stated that real estate would not be sufficiently liquid to be includable at market value in the tax calculation, Tr. of Oral Arg. 36, but he later qualified this statement by suggesting that land might be includable if it could be established that it was readily marketable, id., at 42.8
The types of assets in which corporations lawfully may invest earnings and profits embrace the total range of property interests. They include, to name only a few examples, unimproved real estate within the anticipated growth pattern of a major urban area, improved real estate, unlisted securities of growth corporations that have not “gone public,” undivided interests in oil or mining ventures, and even objects of art. At various times and depending upon conditions, any of these assets may be viewed as—and in fact may be—readily marketable and therefore “liquid.” The unrealized appreciation of such assets may well bear upon the realistic financial condition of a corporation, however it is defined. In light of these economic facts, the sweep of today’s decision presents problems both for corporate taxpayers and the Government.9
8 The following hypothetical example suggests the difficulty of application of today’s decision. If petitioner had invested the same $147,000 of earnings in southern pine timberlands, and if by the end of the tax years in question the unrealized appreciation in value of these lands was precisely the same $1,475,000 and $2,416,000, respectively, as was the appreciation of the Xerox stock here at issue, would the Commissioner have been entitled to take the unrealized appreciation into account? In many instances, well-situated timberlands have appreciated in value as much as or more than most marketable securities. Such lands are not carried on corporate balance sheets as current assets, and yet experience indicates that growing timber and timberlands are often highly marketable.
91 hardly think that the Court’s brandishment of the threat of criminal liability for willful tax evasion through investment in a
c
I further think that the Court’s decision to attach significant tax consequences to the market price of a volatile stock at a particular point in time will lead to unfairness in the application of the accumulated earnings tax. The Court’s net liquidation formulation seems to assume, and nothing in the opinion dispels this assumption, that readily marketable assets are to be valued as of the end of the tax year in question. Moreover, the Court apparently would treat all marketable securities the same for the purpose of this valuation. No distinction is drawn or even suggested among the wide variety of securities that are held as corporate assets.
The market price of a short-term Treasury note, at most only fractionally different from its cost basis, would represent its value under any test. But few financial analysts or economists would say that the market quotation of a common stock at any particular time necessarily
particular type of asset, see ante, at 630 n. 11, will suffice to deter future investment decisions made with the intention of avoiding the pitfalls of this decision. I cannot agree with the Court’s suggestion that this motivation would convert an otherwise legitimate investment choice into a criminal offense. Corporate management considers the potential tax implications of countless business decisions and might reasonably be expected to assess the possible impact of a choice between investing in nonliquid or liquid assets on its potential future liability for the accumulated earnings tax. “The fact that the incidences of income taxation may have been taken into account by arranging matters one way rather than another so long as the way chosen was the way the law allows, does not make a transaction something else than it truly is . . . .” Commissioner v. Wodehouse, 337 U. S. 369, 410 (1949) (Frankfurter, J., dissenting). This is especially true where questions of criminal liability are involved. p. 647617 Powe ll , J., dissenting
reflects its “true” or “realistic” value unless the stock is sold at that price.10 Over a sufficiently long term, the market price of a common stock will reflect, and vary with, the fundamental strength of the issuing corporation’s balance sheet, its earnings record, and its future earnings prospects. But a variety of other factors also affect market price, producing wide swings that do not necessarily correspond to those economic facts. These factors include current conditions of supply and demand in the stock market, immediate confidence in the market in general and in the overall state of the economy, international stability or instability, notions of what is fashionable to buy at a particular time, and a variety of other intangibles. The extent to which the market prices of common stocks fluctuate, often without regard to any concept of “real” value, is illustrated by the tables in the Appendices to this opinion.
Bearing in mind the actual variations in the price of
10 The following swings in the value of Xerox stock illustrate the point: on May 16, 1975, the high was 87 and the low 78%. If petitioner continued to own 10,000 shares, its potentially available source of funds would have shrunk by $85,000 in a single day. In the month of August 1974, Xerox varied in market price from 98 to a low of 74%, a 24.2% swing. Again, assuming a holding of 10,000 shares, the owner would have suffered paper “losses” in that one month of approximately $237,500, or about one-fourth of market value. Considering the entire calendar year of 1965, Xerox sold as high as 71 and as low as 31, a variation on the down side of 55.9% and on the up side of 120%. In dollars, a person who bought 10,000 shares of Xerox in 1965 at its lowest and sold at the highest price would have enjoyed a pretax profit of $400,000. But in 1974, in which the high was 127 and the low 49, a taxpayer whose Xerox stock was assessed on the day of the market’s peak, and who continued to own it, would find himself at the later date having “lost” 61% of what this Court deems the “realistic” or “true” value of the investment. See Appendix A-l, infra.
Pow el l , J., dissenting 422 U. S.
Xerox stock, can it be said that its market price at any given time fairly represents its true or realistic value for the purpose of determining whether earnings and profits have been accumulated unreasonably? The negative answer to this question is indicated, at least for me, by the following hypothetical example. In 1965, one of the tax years at issue in this case, the highest price at which Xerox sold was $71 and the lowest was $31. If two competing corporations each owned 10,000 shares of Xerox stock purchased prior to 1965 at the identical price of $31 per share, and Corporation A’s tax year ended on the day that Xerox hit $71, while Corporation B’s tax year ended on the day it hit $31, Corporation A would have had an unrealized appreciation of $400,000, whereas Corporation B would have had none.
By departing from the cost-basis standard of sound accounting practice, and compelling reliance on an isolated market price of a retained common stock, the Court itself departs from its avowed goal of “economic reality.” Ante, at 627. An average price range at which the stock might have been sold over a relatively long period might produce a more equitable result in some cases. It would not, however, alleviate the basic problem inherent in the Court’s formulation. The taxpayer still could be penalized for having failed to consider, in planning future business needs, the highly ephemeral “value” of unrealized appreciation on common stock. The effect of today’s decision is to hold business management accountable for unrealized appreciation as if it were cash in hand, probably forcing corporate management in many cases to liquidate securities that otherwise it would have elected to retain.11
11 The wide gyrations in value of some of the equity securities listed in the Appendices to this opinion illustrate the point. For example, on May 16, 1975, the common stock of the Falstaff Corp, fell 20.6% in a single day. The Court’s opinion assumes p. 649Management decisions during the course of a year, including decisions whether and when to pay dividends and in what amounts, cannot be made intelligently on the basis of an asset so volatile that it may depreciate in market value as much as 8% in a single day and 61% in a year. Uncertainty of this magnitude could only be avoided by liquidation of assets that have appreciated in value. I find nothing in the language or purpose of this tax that justifies such detrimental interference with sound corporate management.
IV
The Court places major reliance on Helvering v. National Grocery Co., 304 U. S. 282 (1938), finding that that opinion “forecloses the present taxpayer’s case.” Ante, at 631. I respectfully suggest that the Court’s interpretation of National Grocery will not withstand close scrutiny of the facts or its actual holding.12
that corporate management should plan to satisfy future business needs from the unrealized appreciation in value of such securities at a given point in time. The instability of market prices of common stocks suggests that this assumption is unsound.
12 The basic facts of National Grocery are not fully revealed in this Court’s opinion, but must be obtained from the opinions of the Board of Tax Appeals, 35 B. T. A. 163 (1936), the Court of Appeals for the Third Circuit, 92 F. 2d 931 (1937), and the briefs filed in this Court by the parties. In addition to those set forth above, the following are relevant: the decline in market value of the taxpayer’s listed securities in the fiscal year aggregated $943,500; the $2,000,000 shrinkage figure mentioned by this Court included, in addition, the taxpayer’s attempted elimination of $1,068,000 cost value of bank stocks claimed to be wholly unmarketable. Brief for Respondent in No. 723, O. T. 1937, pp. 34-35. In addition, as appears from the opinion of the Court of Appeals, National Grocery also claimed “that [its] merchandise shrank in value well on to a quarter million dollars, and the real estate declined in value $125,000.” 92 F. 2d, at 933. All of this alleged depreciation and shrinkage was
National Grocery, its stock owned by a sole shareholder, was organized in 1908 with an authorized capital of $5,000; its business prospered over the years, so that by January 31, 1931 (the taxable year there at issue), its earned surplus was $7,939,000. These earnings notwithstanding, National Grocery’s “only dividends . . . ever paid ... up to January 31, 1931, were a dividend of $25,000 in 1917, and a dividend of a like amount in 1918.” National Grocery Co. v. Commissioner, 35 B. T. A. 163, 164 (1936). The corporation’s net profits for the four fiscal years preceding fiscal year 1931, all of which were retained rather than distributed, averaged in excess of $800,000 annually. National Grocery earned some $864,- 000 during the tax year in question, none of which was distributed as a dividend. Addressing the taxpayer’s attempt to offset the depreciation of some of its assets, the Court noted:
“Depreciation in any of the assets is evidence to be considered by the Commissioner and the Board in determining the issue of fact whether the accumulation of profits was in excess of the reasonable needs of the business. But obviously depreciation in the market value of securities which the corporation continues to hold does not, as matter of law, preclude a finding that the accumulation of the year’s profits was in excess of the reasonable needs of the business.” 304 U. S., at 291.
When National Grocery is read in light of the facts and issues there presented—as it must be in order to understand the Court’s passing statement—it is readily apparent that the holding in that case does not govern the issue here. The central issue there was the
claimed to have occurred in the taxable year, and was sought to be offset against net earnings for that year. p. 651definition of “gains and profits”: specifically, whether “gains,” a term replaced in the present statute by “earnings,” qualified the meaning of “profits.” The Court apparently felt justified in devoting little attention to the issue, for it was plain in light of the huge accumulation of earnings over time that the taxpayer would be liable even if it were allowed to offset the asserted depreciation. Finally, it is significant that National Grocery’s “accumulation of earnings” was computed on the basis of book value or cost. Indeed, all of the relevant figures were so computed, including the $7,393,000 surplus that had been accumulated over time.
I therefore find no justification for the view that National Grocery forecloses consideration of the question here presented. Moreover, even if I could agree with the Court’s interpretation of that case, I would refuse to follow a rationale so plainly at odds with the statutory language and so conducive to uncertainty and unfairness.
V
The uncertainties the Court has now read into this penal statute correspondingly vest in the Internal Revenue Service an inappropriate latitude in its administration. In light of today’s decision, the Commissioner will have wide and virtually uncontrolled discretion in deciding which corporations will be subject to additional taxation, or at least in deciding which will be required to rebut the presumption that earnings were accumulated to evade shareholder tax liability. Until today’s decision, management, in trying to anticipate what a Commissioner would deem an unreasonable accumulation, at least could rely on the corporation’s earned surplus account as establishing its accumulated earnings and profits. Now this dependable benchmark has become an “irrelevant gauge” of a corporation’s “true financial con- p. 652dition,” and in many cases management can only speculate about the Commissioner’s future determination of values nowhere reflected in the corporation’s books. As commentators have noted, see B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders If 8.01, p. 8-4 (3d ed. 1971), the decision to impose the accumulated earnings tax inevitably involves “a hindsight verdict on management’s business judgment.” The Court’s decision does not impose identifiable standards on the Commissioner’s exercise of this extraordinary “hindsight” authority, but leaves it openended. It is unlikely, to say the least, that Congress intended to leave small and medium-sized businesses— those most often the target of this tax—exposed to this degree of administrative discretion in the imposition of a potentially heavy penalty tax.
[Appendices start on page 653.] p. 653617 Appendix A-l to opinion of Pow ell , J., dissenting
APPENDIX A-l TO OPINION OF POWELL, J.,
DISSENTING
The volatility and transient character of market prices of a common stock are illustrated by the following tables:*
TABLE I
XEROX CORP. COMMON STOCK+
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year: 1965.................................... . 71 31 -56.3 1974.................................... . 127 49 -61.4
Appendix A-2 to opinion of Pow el l , J., dissenting 422 U. S.
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APPENDIX A-4 TO OPINION OF POWELL, J.,
DISSENTING
TABLE IV
WALL STREET JOURNAL
Friday, May 16, 1975, p. 33
Daily Percentage Leaders On N. Y. Stock Exchange
NEW YORK—The following list shows the stocks that have gone up the most and down the most based on percent of change on the New York Stock Exchange regardless of volume for Thursday.
Net and percentage changes are the difference between the previous closing price and yesterday’s last price.
UPS
Name iSales (hds) High Low Last Net Pct.