Doc 2006-2975 (3 pgs)
By Robert Willens
Robert Willens is a managing director with Lehman
Brothers Inc., New York.
In this column, Willens will discuss current issues
in corporate taxation.
The question of when an increase in stock ownership
arising from a sale of stock between siblings can, by itself,
cause the occurrence of an ‘‘ownership change’’ within
the meaning of section 382(g) — a subject first addressed
by the IRS in ILM 200245006, Doc 2002-24976, 2002 TNT
218-16 (July 25, 2002), and then by the Tax Court1 — was
recently answered in the government’s favor by the Fifth
Circuit Court of Appeals in the controversial case of
Garber Industries, Inc. v. Commissioner, _F.3d_, Doc 2006552, 2006 TNT 7-7 (5th Cir. 2006).
The Notion of an Ownership Change
To inhibit the practice of ‘‘trafficking’’ in net operating
losses, Congress enacted, in the Tax Reform Act of 1986,
comprehensive changes to section 382. That section is
triggered by the occurrence, with respect to a loss corporation, of an ownership change. If such a change takes
place, the amount of taxable income earned by the ‘‘new
loss corporation’’ that the preownership change NOLs
(and recognized built-in losses) can offset in any tax year
ending after the date of the ownership change is an
amount known as the ‘‘section 382 limitation.’’ See section 382(a). The section 382 limitation, in turn, is calculated by multiplying the value of the loss corporation’s
stock immediately before the ownership change by the
long-term tax-exempt rate. See section 382(b). The section
382 limitation can be augmented by recognized built-in
gains (RBIGs). The loss corporation therefore can increase
the section 382 limitation (so that a larger amount of
taxable income can be offset by prechange NOLs) if it
possesses, at the time of the ownership change, net
unrealized built-in gains (NUBIGs) that are not de minimis (that is, they exceed the lesser of $10 million or 15
percent of the aggregate value of the loss corporation’s
assets) and those gains are recognized during the fiveyear recognition period, which begins on the date of the
ownership change. For that purpose, a NUBIG (which
1
See Garber Industries Holding Co. v. Commissioner, 124 T.C. 1,
Doc 2005-1549, 2005 TNT 16-8 (2005).
TAX NOTES, March 6, 2006
can lead to an RBIG) is the amount by which the value of
an asset exceeds its basis at the time of the ownership
change. The term also encompasses items of income
recognized after the change date that are attributable to
periods before the change date. See generally section
382(h). Moreover, under Notice 2003-65, IRB 2003-40, Doc
2003-20406, 2003 TNT 178-14 (Sept. 12, 2003), an exceedingly taxpayer-friendly document, an asset can produce
RBIGs (measured by the excess of the hypothetical depreciation or amortization associated with the asset over
the actual depreciation or amortization associated therewith; the hypothetical depreciation or amortization is
determined as if, at the time of the ownership change, a
section 338 election had been made for the loss corporation so the basis of its assets, for purposes of this
calculation, had been stepped up) even though that asset is
not disposed of during the recognition period.
An ownership change takes place if, immediately after
an ‘‘owner shift’’ or an ‘‘equity structure shift,’’ the
percentage of stock of the loss corporation owned by one
or more of its 5 percent shareholders has increased by
more than 50 percentage points relative to the lowest
percentage of stock owned by such person(s) at any time
during the testing period (the three-year period ending
on the date of the owner or equity structure shift).2
The Garber Industries Facts
The facts of Garber Industries are deceptively uncluttered. Garber Industries was a loss corporation (its NOLs
as of the end of its 1997 tax year were in excess of $20
million). The issue was whether Garber Industries was an
‘‘old loss corporation.’’ That in turn depended on
whether, as a result of shifts in the ownership of its stock,
it experienced an ownership change. At the end of its
1997 tax year, 19 percent of its stock was owned by
Charles Garber while another 65 percent was owned by
his brother, Kenneth Garber. In April 1998 Kenneth and
his wife sold all of their stock in Garber Industries to
Charles. Accordingly, as of the close of the 1998 tax year,
Charles owned 84 percent of the stock. It therefore
appeared that an ownership change had taken place
because, relative to Charles’s lowest percentage ownership of stock at any time during the testing period,
Charles (obviously a 5 percent shareholder) — as a result
of his purchase of Kenneth’s and his wife’s stock — had
2
No testing period, however, can begin before the first day of
the first tax year from which there is a carryforward of an NOL
to the first tax year ending after the testing date. Moreover, if
there has already been an ownership change, the testing period,
for purposes of determining whether a second ownership
change has taken place, will begin no earlier than the day
following the change date for the earlier ownership change. See
reg. section 1.382-2T(d).
1099
(C) Tax Analysts 2006. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
When Siblings Are Regarded as
Strangers
Doc 2006-2975 (3 pgs)
COMMENTARY / OF CORPORATE INTEREST
Did an Ownership Change Occur?
The Fifth Circuit asked the proper question: Did an
ownership change take place as a result of Charles’s
acquisition of Kenneth’s stock in 1998? The answer, the
court said, depended entirely on whether the ownership
of Charles’s and Kenneth’s stock could be aggregated or,
the court went on to say, as if the two concepts were
interchangeable, attributed to each other. However, those
concepts — aggregation and attribution — are not identical. Unfortunately, by treating them as such, the decision the court rendered, although in our view reaching
the correct result, does so for reasons that are not entirely
persuasive.
The case turned on the interpretation of a provision
that had not been previously addressed in a decided case
or published ruling: section 382(l)(3)(A)(i). That section
states that section 318 (relating to constructive ownership
of stock) will apply in determining ownership of stock
(for purposes of determining whether an ownership
change has taken place) except that (i) sections 318(a)(1)
and 318(a)(5)(B) will not apply and (ii) an individual and
all ‘‘members of his family’’ described in section 318(a)(1)
will be treated as one individual. Arguably, that passage
means, as Bittker and Eustice suggest (Federal Income
Taxation of Corporations and Shareholders, para. 14.43(2)(d)),
that sales between family members described in section
318(a)(1) should be disregarded. Ginsburg and Levin
(Mergers, Acquisitions and Buyouts, para. 1208.1.5) seem to
reach the same conclusion. Their treatise, on the interpretation of section 382(l)(3)(A), states that an individual and
that individual’s spouse, children, grandchildren, and
parents — the persons specified in section 318(a)(1) — are
treated as one person.
Thus, in a sense, if the words of the statute were
scrupulously applied, the case would ‘‘decide itself’’: The
family members listed in section 318(a)(1) are confined to
one’s spouse, children, grandchildren, and parents. The
list does not include siblings. Accordingly, because the
Garber sale was between siblings, it would follow that
the sale could not be disregarded and the increase in
ownership that Charles experienced as a result of the sale
would itself create for Garber Industries an ownership
change. The court at points seemed to embrace that
‘‘plain meaning’’ approach to the interpretation of section
382(l)(3)(A)(i). For example, it stated that section
382(l)(3)(A)(i) replaces the attribution rules with the
family grouping model (that is, the attribution rules were
replaced by aggregation rules) and, when determining
whether stock owned by family members can be aggregated, the only question is whether they are members of
the same family as described by section 318(a)(1). Had
the reasoning terminated there, the decision would have
been a clean one, adhering to the plain language rule, and
1100
the confusion that the court’s supplementary reasoning
will likely engender could be avoided.
Aggregation Isn’t the Same as Attribution
The sale, the court said, was not between family
members (and hence could not be disregarded) because
the family members listed in section 318(a)(1) — and
incorporated into section 382(l)(3)(A)(i) — do not include
siblings. Accordingly, the court went on to say, the stock
owned by each brother is not treated as owned by the other
and therefore the transaction between them triggers an ownership change.
The court seemed to be saying that a sale of stock
between brothers could be disregarded under section
382(l)(3)(A)(i) if the stock owned by one brother would
be, before the actual acquisition of that stock, attributed
under section 318(a) to the other brother. That is not,
however, what section 382(l)(3)(A)(i) says. That provision
ignores an acquisition of stock when, and only when, the
parties to that acquisition are members of the same
family, as that term is defined in section 318(a)(1). If they
are not members of the same family, the acquisition of
stock, and the increase in ownership that it precipitates, is
counted for purposes of gauging the existence of an
ownership change, even though the stock so acquired was
constructively owned (by the acquirer) before the acquisition. Section 382, after all, does not say to count only
increases in ownership that result from acquisitions of
stock from persons the ownership of whose stock would
not be attributed under section 318(a) to the person
acquiring the stock. The court, therefore, we respectfully
submit, confused the notions of aggregation and attribution and that in turn produced — as we read it — a
confusing decision that in the final analysis turns wholly
on whether the parents or grandparents of the siblings
were living or deceased, or were shareholders or nonshareholders of the loss corporation.
The parents and grandparents of the Garber brothers
were all deceased. Thus, the IRS, in ILM 200245006, in
attempting to account for the fact that the prohibition on
so-called double family attribution3 is rendered inapplicable by section 382(l)(3)(A), concluded that the stock
owned by one brother could not, through their parents or
grandparents, be attributed to the other brother because
stock cannot be attributed under section 318(a)(1) (and
then reattributed under that same section to another
family member) to an individual who is deceased. The
Tax Court, although it found in favor of the government
on the issue of whether an ownership change occurred,
disparaged that approach. It could not believe that Congress intended for the issue to turn on a parent’s or
grandparent’s health. Thus, in its judgment, the ability to
attribute the stock owned by one sibling to another
sibling through the parents or grandparents of those
siblings depended on whether those ancestors were, at
3
Section 318(a)(5)(B), which prohibits ‘‘double family attribution,’’ states that stock constructively owned by an individual, by reason of the application of section 318(a)(1), will not
be considered owned by that individual for purposes of making,
under section 318(a)(1), another family member the constructive
owner of that stock.
TAX NOTES, March 6, 2006
(C) Tax Analysts 2006. All rights reserved. Tax Analysts does not claim copyright in any public domain or third party content.
experienced within the testing period a 65 percentage
point increase in ownership. The IRS asserted that an
ownership change had indeed occurred and therefore the
section 382 limitation was brought into play. The amount
of Garber Industries’ taxable income that was eligible to
be offset by its prodigious NOL was therefore dramatically diminished and its ‘‘unsheltered’’ taxable income
was correspondingly increased. The result was a $311,188
deficiency assessment that the brothers contested.
Doc 2006-2975 (3 pgs)
COMMENTARY / OF CORPORATE INTEREST
TAX NOTES, March 6, 2006
Finally, to the extent the decision is based on the view
that a sale by one person (here, Kenneth Garber) can be
treated as a sale by another person (his father or mother
if they were living and were shareholders of the corporation) simply because the parties are members of the
same family, it seems incorrect. See, in that regard, Estate
of Hanna v. Commissioner, 319 F.2d 54 (6th Cir. 1963), and
Rev. Rul. 77-439, 1977-2 C.B. 85. It is well settled that a
sale by one person cannot be treated as a sale by another
person except when, as in Rev. Rul. 68-388, 1968-2 C.B.
122, the party who actually transfers title to the property
functions merely as a ‘‘conduit’’ through whom the true
party in interest transfers title and possession to the
property in question. There is no accepted theory that
converts a sale by one person into a sale by another
person simply because the persons are related.
Therefore, we conclude that the decision reached by
the Fifth Circuit was the correct one but arguably for the
wrong reasons. The sale was not between family members. That should end the inquiry.4 It does not matter,
based on a plain reading of the statutory language, that
the stock so sold would be attributed to the person
acquiring the stock. Further, the inapplicability of section
318(a)(5)(B) does not mean that a sale by one brother is
transformed into a sale by his father or mother (but only
if they are shareholders of the corporation) to the purchasing brother with the result that the increase in
ownership resulting from that sale is disregarded for
purposes of determining whether an ownership change
has taken place.
4
See, in this regard, section 355(d)(7), another aggregation
rule, which provides that a person and all persons related to that
person, within the meaning of sections 267(b) and 707(b), will be
treated as one person. Here, however, the members of one’s
family includes only siblings, spouses, ancestors, and lineal
descendants. See section 267(b)(4). Oddly, even if the parties to
the transactions are members of the same family, so that the
aggregation rules apply, the sales of stock are nonetheless
‘‘purchases’’ for purposes of section 355(d). Ginsburg and Levin
(at para. 1009.5) find that result to be ‘‘truly foolish.’’
1101
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the time of the transaction under scrutiny, shareholders
of the loss corporation. Thus, contrary to its previous
views regarding the scope of the attribution rules, expressed in cases like Levin v. Commissioner, 385 F.2d 521
(2d Cir. 1967), and Coyle v. United States, 415 F.2d 488 (4th
Cir. 1968), the Tax Court concluded that those rules could
operate when the party to whom stock would otherwise
be attributable was himself an actual shareholder of the
corporation.
The Fifth Circuit seemed to endorse that approach. It
said the Tax Court properly interpreted section 382 as
applied to a sale of stock between brothers when no
parent or grandparent of the brothers was a shareholder.
Section 382, it went on to say, lists the relatives of a
shareholder whose stock can be aggregated with that of
the shareholder and the list of relatives does not include
siblings. Attempting, the court said, to perform the
‘‘aggregation analysis’’ through a nonshareholder parent,
as the Garber brothers sought to do, must fail.
That approach, however, does not seem consistent
with the statute’s plain meaning. The court’s decision, we
believe, is premised on an overly broad reading of section
382(l)(3)(A)(i). The section operates to disregard a sale of
stock and an ensuing increase in the purchasing shareholder’s ownership interest in the loss corporation only
when the parties to the transaction are members of a
family described in section 318(a)(1) — and siblings are
not members of such a family. The section does not
operate when the parties to the transaction are not
members of a family but the stock ownership of one
party is still attributed under section 318(a) to the other
party. Accordingly, it should not matter whether the
ancestors of the parties are living or deceased or are
shareholders of the corporation or nonshareholders.
Moreover, if the section turned on whether the stock
purchased was, because of the application of the attribution rules, already owned by the purchaser, it would
appear that the relative through whom the stock would
be attributed could play a role in the transaction regardless of whether that relative is an actual shareholder of
the corporation. It is well settled that stock can be
attributed through a nonshareholder of the corporation.
See Levin and Coyle, supra.