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R Ball v. Commissioner of Internal Revenue

United States Court of Appeals, Third Circuit

February 12, 2014

R BALL FOR R BALL III BY APPT
v.
COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 11-17593) R BALL CHILDREN TRUST 9/9/1969
v.
COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 11-17594) ETHEL BALL FOR R BALL III APT 2/9/1967
v.
COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 11-17595) ETHEL BALL FOR A L BALL AS APPT
v.
COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 11-17596) R BALL JR. CHILDRENTRUST 1/29/1970
v.
COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 11-17597) R BALL JR. F/B/O R BALL III 12/22/1976
v.
COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 11-17598) R BALL FOR A L BALL BY APPT
v.
COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 11-17599) R BALL CHILDREN TRUST 1/24/1973
v.
COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 11-17600) RUSSELL BALL JR SEC FIRST 9/9/1967
v.
COMMISSIONER OF INTERNAL REVENUE (Tax Court No. 11-17601) R BALL FOR R BALL III BY APPT; R BALL CHILDREN TRUST 9/9/1969; ETHEL BALL FOR R BALL III APT 2/9/1967; ETHEL BALL FOR A L BALL AS APPT; R BALL JR. CHILDRENTRUST 1/29/1970; R BALL JR. F/B/O R BALL III 12/22/1976; R BALL FOR A L BALL BY APPT; R BALL CHILDREN TRUST 1/24/1973; RUSSELL BALL JR SEC FIRST 9/9/1967, Appellants

Argued: December 17, 2013

On Appeal from the United States Tax Court (Tax Court Nos. 17593-11, 17594-11, 17595-11, 17596-11, 17597-11, 17598-11, 17599-11, 17600-11, 17601-11) Tax Court Judge: Honorable Kathleen Kerrigan

Nancy Winkelman, Esq. [ARGUED] Timothy K. Lewis, Esq. Schnader Harrison Segal & Lewis LLP Attorneys for Appellants

Francesca Ugolini, Esq. [ARGUED] Richard Farber, Esq. Kathryn Keneally, Esq. United States Department of Justice, Tax Division Attorneys for Appellee

Before: JORDAN, VANASKIE, and VAN ANTWERPEN, Circuit Judges.

OPINION

VAN ANTWERPEN, Circuit Judge.

I. INTRODUCTION

An S corporation ("S Corp.") is a small business corporation that is permitted to have its corporate income, losses, deductions, and credits attributed to its shareholders. This appeal arises out of nine consolidated cases before the United States Tax Court regarding the tax implications of an S Corp.'s election to treat its subsidiary as a "qualified subchapter S subsidiary" ("Qsub") under Internal Revenue Code § 1361.[1] Specifically, the parties disagree as to whether the Qsub election and subsequent sale of the S Corp. parent creates an "item of income" under § 1366(a)(1)(A)[2] thereby requiring the parties who held stock in the parent S Corp. to adjust their bases in stock under § 1367(a)(1)(A).[3] For reasons which follow, we affirm the decision of the Tax Court, finding an increase in stock bases and declared losses to be improper.

II. FACTS

In June 1997, ten trusts for the benefit of the Ball family ("Trusts")[4] acquired direct ownership of all shares of American Insurance Service, Inc. ("AIS")[5] with an aggregate basis in AIS stock totaling $5, 612, 555. In 1999, the Trusts formed Wind River Investment Corporation ("Wind River"), a Delaware corporation. The Trusts then contributed their shares in AIS in exchange for all of the shares of Wind River. This resulted in Wind River owning all of the shares of AIS. Effective June 4, 1999, Wind River designated itself a subchapter S Corporation. On February 28, 2003, Wind River elected to treat AIS as a Qsub under § 1361(b)(3).[6] Prior to the Qsub election, the Trusts' aggregate adjusted basis in the Wind River stock was $15, 246, 099. Following the Qsub election, the Trusts increased their bases in the Wind River stock from $15, 246, 099 to a new basis of $242, 481, 544.[7]

Following the Qsub election and stock basis adjustments, the Trusts sold their interests in Wind River to a third party, Fox Paine, on September 5, 2003. After transaction costs, this sale yielded $230, 111, 857 in cash and securities in exchange for all of the Wind River stock.[8] Even though they had received $230, 111, 857 from the sale, the Trusts claimed a loss in the amount of $12, 247, 229.[9] This was calculated as the difference between the amount actually received for the sale and the new basis in the Wind River stock. The Trusts shareholders' 2003 tax returns were filed citing the aforementioned capital loss.

The Internal Revenue Service ("IRS") determined the Trusts should not have increased their bases in the Wind River stock to $242, 481, 544 following the Qsub election. The IRS determined instead that a capital gain of approximately $214 million had been realized from the sale of Wind River to Fox Paine. This resulted in a cumulative tax deficiency of $33, 747, 858 for the nine trusts that have filed appeals in this case. Deficiency notices were sent to the Trusts on May 18 and 19, 2011, stating "the Qsub election and the resulting deemed I.R.C. § 332[10] liquidation did not give rise to an item of income under I.R.C. § 1366(a)(1)(A); therefore, [the Trusts] could not increase the basis of their [Wind River] stock under I.R.C. [§] 1367(a)(1)(A)." (Appendix ("App.") at A373.) The Trusts filed petitions with the United States Tax Court seeking a redetermination of deficiencies under the jurisdiction of §§ 6213(a) and 7442. The cases were consolidated and submitted for decision on stipulated facts, under Tax Court Rule 122, [11] as R. Ball for R. Ball III By Appt., et al. v. Commissioner, 105 T.C.M. (CCH) 1257, 2013 WL 452722 (2013). As previously noted, the Tax Court found the increase in stock basis and declared loss to be improper.

III. TAX COURT PROCEEDINGS

The main issue before the Tax Court and now on appeal is whether or not a Qsub election creates an "item of income" for the parent corporation under § 1366(a)(1)(A). The Trusts relied on their assertion that the election "resulted in a gain derived from dealings in property and, therefore, created an item of income under § 61(a)."[12]R. Ball, 2013 WL 452722, at *4. If the election resulted in an "item of income, " the new higher bases and resulting tax losses are proper. If it did not result ...


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