Brotherly Stock Sale Caused an Ownership Change

In Garber Industries Holding Co., 124 TC 1 (2005), the Tax Court held that a stock sale between two brothers resulted in an ownership change under Sec. 382. This case was a follow-up to Field Service Advice 200245006, in which the Service opined that a stock transfer between siblings resulted in an ownership change. While the Tax Court and the IRS reached the same conclusion, each conclusion was based on a different interpretation of the applicable law.

Background

Garber Industries was a closely held C corporation with pre-1997 net operating loss (NOL) carryovers. The two Garber brothers, Kenneth and Charles, had owned 68% and 26%, respectively, of the corporation’s common stock since inception (1982). Their spouses, children and other siblings owned the remaining stock. Their parents never owned any of the stock.

In 1996, the corporation underwent a D reorganization, in which Charles’ ownership interest decreased from 68% to 19% and Kenneth’s increased from 26% to 65%. In April 1998, Kenneth sold all of his shares to Charles, causing the latter’s ownership to increase 65%, from 19% to 84%.

All in the Family?

The sale, according to the IRS, caused an ownership change under Sec. 382(g)(1), because there was a greater-than-50% increase in a 5% shareholder’s ownership. This change resulted in the disallowance of a large portion of the NOL deduction on the corporation’s 1998 return.

The taxpayer argued that the sale between the brothers had to be disregarded under Sec. 382(l)(3)(A)(i), which treats all the members of one family (as determined under Sec. 318(a)(1)) as one shareholder. However, Sec. 318 does not include siblings as members of the same family but, rather, includes an individual and his or her spouse, children, grandchildren and parents. In making its argument, the taxpayer stated that although siblings are not members of the same family under Sec. 318(a)(1), the brothers are both members of the same family unit that includes their parents and grandparents.

The Service claimed that consideration of the family as a single shareholder only applies to living persons (i.e., if the parents and grandparents are still living). It argued that even if the brothers were members of the same family, neither their parents nor grandparents were alive during the three-year testing period preceding the transaction; thus, there was no family unit to be treated as a single shareholder.

The Tax Court’s Interpretation

The court felt that the statute’s language was sufficiently ambiguous for both positions to have some merit. However, it ultimately concluded that neither party’s interpretation was correct, as both had the potential for expansive definitions of the family unit and seemed inconsistent with the legislative intent. Instead, the court set forth its own idea—Sec. 382(l)(3)(A)(i)’s aggregation rule should apply only to individuals who are shareholders (as determined under the Sec. 382(l)(3)(A) attribution rules) in the loss corporation. In other words, an aggregation of family members should include only individuals who own stock (either directly or indirectly) in the loss corporation. Under this interpretation, sibling shareholders could not be aggregated if neither their parents nor grandparents were direct shareholders. Thus, the court upheld the Service’s position, although it disagreed with its interpretation of the statute.

Conclusion

Although a loss for the taxpayer, Garber Industries is welcome guidance for tax advisers working through Sec. 382’s often-ambiguous provisions. In addition, it serves as a reminder of the importance of tracking changes in stockholdings of closely held loss corporations, as it is often possible to prevent an ownership change from occurring by monitoring ownership changes within the moving three-year testing period.

From Maureen McGetrick, CPA, New York, NY, and Catherine Fox-Simpson, CPA, MST, Dallas, TX