December 19, 2018
Under tax law, there are several provisions that treat transactions between “family members” differently. Although it may seem simple to determine who your relatives are, two brothers found out in Tax Court that they aren’t related for purposes of one such provision.
The 2005 case involved a net operating loss (NOL) claimed by the family corporation.
Facts of the case: After a corporate reorganization, Charles Garber owned 19% of the stock of Garber Industries Holding Co., while his brother Kenneth owned 65%. Other relatives owned stock in the company, but neither of the brothers’ parents did. Subsequently, Kenneth sold all his shares to his brother, giving Charles 84% ownership.
On its tax return, the company claimed an NOL of $809,000 ($730,000 for AMT purposes). But the IRS reduced the NOL to $121,000, citing a rule (Under IRC Section 382) that limits NOL carryforwards in years following a change in ownership. This unfavorable rule can potentially come into play whenever the stock ownership in a corporation changes by more than 50%.
The brothers argued that changes in stock ownership between themselves should be disregarded because of the family attribution rules. Under these rules, an individual and his or her spouse, children, grandchildren and parents are treated as one individual.
In the usual situation, the family attribution rules work against you. For instance, you may be treated as constructively owning stock that your spouse owns individually. However, in the Garber case, the taxpayers argued that the family attribution rules should apply. In other words, by having the two family members treated as one shareholder, the corporation’s NOL wouldn’t be limited because there would be no ownership change.
But are they family members under the relevant provisions of the tax law? Here are the arguments:
The brothers – Although siblings aren’t specifically covered by this particular tax law definition, the brothers argued the rules should apply anyway because of the relationship to their parents and grandparents.
The IRS – The Tax Court rejected both arguments. In its ruling, the judge stated: “We see no rational basis for Congress’s having drawn a distinction in this context between siblings whose parents happen to be living and those whose parents happen to be deceased; The former are no more related than the latter.”
Looking at the legislative history of the relevant code sections, the court concluded that family aggregation only applies to individuals who are corporate shareholders. The stock of the sibling shareholders couldn’t be aggregated for loss purposes, since neither the parents or grandparents deceased were shareholders. Therefore, the sale of stock results in an ownership change and the limitation on NOLs applies. (Garber Industries Holding Co., 124 TC No. 1)