SCOTUS Reports

Tag: Built-in Gains Tax

  • N.Y. Football Giants, Inc. v. Commissioner, 117 T.C. 152 (2001): Subchapter S Items and Built-in Gains Tax

    N. Y. Football Giants, Inc. v. Commissioner, 117 T. C. 152 (U. S. Tax Ct. 2001)

    In a significant ruling on S corporation taxation, the U. S. Tax Court held that the built-in gains tax under IRC section 1374 is a subchapter S item, necessitating a unified audit and litigation procedure at the corporate level. This decision impacts how S corporations must handle the tax on gains from assets held at the time of conversion from C to S status, affirming the IRS’s jurisdiction over such items without issuing a notice of deficiency for fiscal years 1996 and 1997.

    Parties

    New York Football Giants, Inc. (Petitioner) filed a petition against the Commissioner of Internal Revenue (Respondent) in the U. S. Tax Court. The petitioner was an S corporation challenging the respondent’s determination of built-in gains tax liability for fiscal years 1996, 1997, and 1998.

    Facts

    New York Football Giants, Inc. , an S corporation since 1993, received expansion payments from the NFL in 1996, 1997, and 1998. These payments were reported as capital gains on the corporation’s tax returns. The Commissioner determined that these payments were subject to the built-in gains tax under section 1374 of the Internal Revenue Code, which imposes a corporate-level tax on recognized built-in gains during the first ten years of S corporation status. The Commissioner issued a notice of deficiency for these years, asserting the tax liability, which the petitioner contested, arguing the built-in gains tax was not a subchapter S item.

    Procedural History

    The Commissioner moved to dismiss the case for lack of jurisdiction regarding fiscal years 1996 and 1997, asserting that the built-in gains tax is a subchapter S item that should be determined through a unified audit and litigation procedure, and thus a notice of deficiency was improper. The petitioner argued against this classification and the validity of the relevant regulations. The Tax Court granted the Commissioner’s motion to dismiss and strike as to fiscal years 1996 and 1997, affirming that the built-in gains tax is a subchapter S item and must be addressed through the unified audit procedures.

    Issue(s)

    Whether the built-in gains tax imposed under section 1374 of the Internal Revenue Code is a subchapter S item that must be determined through a unified audit and litigation procedure at the corporate level?

    Rule(s) of Law

    The Internal Revenue Code section 6245 defines a subchapter S item as any item of an S corporation that is more appropriately determined at the corporate level than at the shareholder level, as provided by regulations. Temporary Regulation section 301. 6245-1T(a)(1)(vi)(G) specifically includes taxes imposed at the corporate level, such as the section 1374 built-in gains tax, as subchapter S items.

    Holding

    The U. S. Tax Court held that the built-in gains tax under section 1374 is a subchapter S item. As such, it must be determined through a unified audit and litigation procedure at the corporate level, and the Commissioner’s notice of deficiency was invalid for fiscal years 1996 and 1997.

    Reasoning

    The court’s reasoning centered on the statutory framework and regulations governing S corporations. It emphasized that the built-in gains tax is determined based on events at the corporate level, specifically the appreciation of assets held at the time of conversion from C to S status. The court found that Temporary Regulation section 301. 6245-1T, which classifies the built-in gains tax as a subchapter S item, was not arbitrary, capricious, or contrary to the statute, and thus valid under the Chevron deference standard. The court rejected the petitioner’s contention that the tax should be considered an S item at the shareholder level, noting that it is assessed against and paid directly by the S corporation, not the shareholders. Furthermore, the court considered policy considerations favoring a unified audit process to avoid inconsistent determinations and to streamline the tax administration process for S corporations.

    Disposition

    The court granted the Commissioner’s motion to dismiss and to strike as to fiscal years 1996 and 1997, indicating that a notice of final S corporation administrative adjustment should have been issued for those years instead of a notice of deficiency.

    Significance/Impact

    This decision has significant implications for S corporations regarding the handling of the built-in gains tax. It clarifies that such tax must be addressed through the unified audit and litigation procedures, ensuring consistent treatment among shareholders. The ruling reinforces the IRS’s authority to regulate S corporation items at the corporate level and may affect how S corporations report and challenge tax liabilities related to built-in gains. Subsequent courts have cited this case when dealing with similar issues of subchapter S items, and it has influenced the practical approach to S corporation taxation.

  • Coggin Automotive Corp. v. Commissioner, T.C. Memo. 2001-123: ‘Most Recent Election’ Rule for S Corp Built-In Gains Tax

    Coggin Automotive Corp. v. Commissioner, T.C. Memo. 2001-123 (2001)

    When a corporation revokes its S corporation election and later re-elects S status, the ‘most recent election’ rule of Section 1374(d)(9) of the Internal Revenue Code applies, subjecting the corporation to the built-in gains tax for a new 10-year period based on the re-election date, regardless of a prior S election before 1989 and associated transition rules.

    Summary

    Coggin Automotive Corp., initially a C corporation, elected S corporation status in 1988. It revoked this election in 1989 and operated as a C corporation until re-electing S status in 1994. During 1994-1996, the IRS assessed deficiencies against Coggin, arguing that gains from asset sales were subject to the built-in gains tax under Section 1374 as amended by the Tax Reform Act of 1986 (TRA). Coggin argued that the transition rule of TRA Section 633(d) should apply because its initial S election was before 1989. The Tax Court held that Section 1374(d)(9), as amended, explicitly refers to the ‘most recent election,’ which was the 1994 re-election, thus subjecting Coggin to the amended built-in gains tax rules for a new 10-year period. The transition rule was deemed inapplicable due to the intervening revocation of S status.

    Facts

    Coggin Automotive Corp. was incorporated in 1977 and operated as a C corporation until February 1, 1988, when it made a valid S corporation election. At the time of the 1988 election, Coggin held assets with unrealized gains and earnings and profits accrued during its C corporation years. These assets included securities, real estate interests, and oil and gas partnership interests. Effective December 1, 1989, Coggin revoked its S election and filed as a C corporation through 1993. On January 1, 1994, Coggin again made a valid S corporation election. During 1994-1996, Coggin sold assets, primarily acquired before 1988, generating gains.

    Procedural History

    The Internal Revenue Service (IRS) issued a notice of deficiency to Coggin for the tax years 1994, 1995, and 1996, asserting deficiencies related to the built-in gains tax. Coggin petitioned the Tax Court to dispute these deficiencies. The case was submitted to the Tax Court fully stipulated, meaning the parties agreed on all the factual details, and the court only needed to decide the legal issue.

    Issue(s)

    1. Whether the transition rule of Section 633(d) of the Tax Reform Act of 1986 applies to Coggin Automotive Corp. for the years 1994-1996, given that Coggin made an S election before 1989 but revoked and re-elected S status.

    2. Whether Section 1374 of the Internal Revenue Code, as amended by the Tax Reform Act of 1986, applies to Coggin’s 1994, 1995, and 1996 taxable years due to its 1994 S corporation re-election.

    Holding

    1. No, the transition rule of TRA Section 633(d) does not apply because Coggin’s S election was not continuous from before 1989 to the years in issue due to the revocation and subsequent re-election.

    2. Yes, Section 1374, as amended, applies because Section 1374(d)(9) explicitly states that references to the ‘1st taxable year for which the corporation was an S corporation’ refer to the ‘1st taxable year for which the corporation was an S corporation pursuant to its most recent election under section 1362.’ Coggin’s ‘most recent election’ was in 1994.

    Court’s Reasoning

    The Tax Court reasoned that the plain language of Section 1374(d)(9), as amended, is clear and unambiguous. The statute directs the court to consider the ‘most recent election’ when determining the applicability of the built-in gains tax. The court stated, “Section 1374, as amended, is applicable to the 10-year period after an S corporation’s ‘most recent election’. Sec. 1374(d)(9).” Coggin’s ‘most recent election’ was in 1994. The court rejected Coggin’s argument that the 1988 election and the transition rule should govern, emphasizing that the revocation of the S election in 1989 interrupted the continuity required for the transition rule to apply. The court noted that when Coggin became a C corporation in 1989, the transition rule became inapplicable. Upon re-electing S status in 1994, Coggin became subject to Section 1374 as amended and in effect at that time. The court also found that this interpretation was consistent with the legislative history of TRA Section 633, which aimed to tax built-in gains of corporations electing S status after 1986.

    Practical Implications

    Coggin Automotive Corp. clarifies that the ‘most recent election’ rule in Section 1374(d)(9) is strictly applied. For practitioners, this case highlights the importance of considering the built-in gains tax implications whenever a corporation re-elects S status after a revocation. Even if a corporation had an S election in place before the Tax Reform Act of 1986 and might have initially benefited from transition rules, a subsequent revocation and re-election resets the clock. The 10-year built-in gains tax period begins anew with the ‘most recent election.’ This decision emphasizes the need for careful tax planning when considering S corporation revocations and re-elections, particularly for corporations holding appreciated assets. It underscores that the IRS and courts will adhere to the literal language of Section 1374(d)(9), focusing on the most recent S election to determine the applicable tax regime.

  • Argo Sales Co. v. Commissioner, 105 T.C. 86 (1995): When Section 481(a) Adjustments Constitute Built-in Gains for S Corporations

    Argo Sales Co. v. Commissioner, 105 T. C. 86 (1995)

    Section 481(a) adjustments attributable to periods before an S corporation election are treated as recognized built-in gains subject to tax under Section 1374.

    Summary

    Argo Sales Co. switched from the cash to the accrual method of accounting, necessitating a Section 481(a) adjustment of $1,336,966. 63 to be spread over six years. After three years, Argo elected S corporation status. The IRS argued the remaining adjustments were built-in gains under Section 1374, taxable at the corporate level. The Tax Court agreed, holding that Section 481(a) adjustments are income items attributable to pre-S corporation periods, thus subject to the built-in gains tax. This decision impacts how corporations transitioning to S status must account for prior accounting method changes.

    Facts

    Argo Sales Co. , an Ohio corporation, changed its accounting method from cash to accrual in 1985 due to its inventory holdings, requiring a Section 481(a) adjustment of $1,336,966. 63. This adjustment was spread over six years as per Rev. Proc. 85-36. Argo included one-sixth of the adjustment in its income for the fiscal years ending March 31, 1986, 1987, and 1988. Effective April 1, 1988, Argo elected S corporation status. The remaining three-sixths of the Section 481(a) adjustment were included in Argo’s S corporation income for the short year ending December 31, 1988, and calendar years 1989 and 1990.

    Procedural History

    The IRS determined deficiencies for the tax years 1988, 1989, and 1990, asserting that the Section 481(a) adjustments were subject to the built-in gains tax under Section 1374. Argo petitioned the U. S. Tax Court, which upheld the IRS’s position, ruling that the adjustments constituted built-in gains.

    Issue(s)

    1. Whether Section 481(a) adjustments are items of income attributable to periods before the first year for which the corporation was an S corporation, within the meaning of Section 1374(d)(5).

    2. Whether the prospective application of Section 1. 1374-4(d) of the Income Tax Regulations prevents the Commissioner from applying Section 1374 to Argo’s Section 481(a) adjustments for the years at issue.

    Holding

    1. Yes, because Section 481(a) adjustments are income items that arise from the period before the S corporation election, and thus are subject to the built-in gains tax under Section 1374(d)(5).

    2. No, because the prospective application of the regulation does not preclude the Commissioner from interpreting and applying the statute to the years at issue based on its legislative history and text.

    Court’s Reasoning

    The court reasoned that Section 1374(d)(5) treats any item of income attributable to periods before the S corporation election as a recognized built-in gain if taken into account during the recognition period. The Section 481(a) adjustment, representing untaxed corporate income from before the S election, fits this description. The court noted the legislative history of Section 1374, which broadly defined “recognized built-in gain” to include income items beyond just the disposition of assets. The court rejected Argo’s argument that the prospective effective date of Section 1. 1374-4(d) of the regulations precluded the Commissioner from applying Section 1374 to the years in question. The court found that the absence of regulations did not relieve it of the duty to interpret the statute, and that the statute’s text and legislative history supported the IRS’s position. The court concluded that the Section 481(a) adjustments were properly subject to the built-in gains tax under Section 1374.

    Practical Implications

    This decision clarifies that Section 481(a) adjustments must be considered when analyzing the built-in gains tax implications for corporations converting to S status. Practitioners should advise clients to account for any such adjustments when planning an S election, as they will be subject to the built-in gains tax. The ruling prevents corporations from using a change in accounting method to avoid corporate-level tax on pre-conversion income. Businesses contemplating a switch to S corporation status should carefully review their accounting method changes and potential Section 481(a) adjustments. Subsequent cases have cited Argo in determining the scope of built-in gains, affirming its application to various types of pre-conversion income.