SCOTUS Reports

Tag: I.R.C. § 118

  • CF Headquarters Corp. v. Commissioner, 164 T.C. No. 5 (2025): Taxability of Government Grants Under I.R.C. §§ 118, 102, and 139

    CF Headquarters Corp. v. Commissioner, 164 T. C. No. 5 (U. S. Tax Ct. 2025)

    CF Headquarters Corp. received a $3. 1 million grant from the Empire State Development Corp. post-9/11 for business recovery. The U. S. Tax Court ruled that these proceeds were taxable income, not excludable as capital contributions, gifts, or disaster relief under I. R. C. §§ 118, 102, and 139, but found the company not liable for an accuracy-related penalty due to substantial authority for its position.

    Parties

    CF Headquarters Corporation, a Delaware corporation wholly owned by Cantor Fitzgerald, L. P. , was the petitioner. The Commissioner of Internal Revenue was the respondent. The case was filed in the United States Tax Court with docket number 22321-12.

    Facts

    In the aftermath of the September 11, 2001, terrorist attacks, the State of New York established the World Trade Center Job Creation and Retention Program (JCRP) to aid affected businesses. CF Headquarters Corp. (petitioner), a holding company owned by Cantor Fitzgerald, L. P. , received a $3,107,500 grant in 2007 under the JCRP as reimbursement for rent expenses paid by its affiliates, Cantor Fitzgerald and Cantor Fitzgerald Securities. The grant was governed by an Amended and Restated Grant Disbursement Agreement (ARDA) which required the petitioner to maintain certain employment levels in New York City. The grant proceeds were lent to Cantor Fitzgerald in exchange for a 49-year promissory note. On its 2007 federal income tax return, the petitioner excluded the grant proceeds from gross income, which the Commissioner contested, asserting the proceeds should be included in gross income and that the petitioner was liable for an accuracy-related penalty under I. R. C. § 6662(a) and (b)(2).

    Procedural History

    The Commissioner issued a Notice of Deficiency determining a deficiency of $1,056,550 and an accuracy-related penalty of $211,310 for the tax year 2007. CF Headquarters Corp. timely filed a petition with the United States Tax Court to contest the deficiency and penalty. The case was reviewed by the full court, and the opinion was written by Chief Judge Kerrigan.

    Issue(s)

    Whether the $3,107,500 in grant proceeds received by the petitioner under the JCRP are excludable from gross income under I. R. C. § 118 as contributions to capital, I. R. C. § 102 as gifts, or I. R. C. § 139 as qualified disaster relief payments?

    Whether the petitioner is liable for the accuracy-related penalty under I. R. C. § 6662(a) and (b)(2) due to a substantial understatement of income tax?

    Rule(s) of Law

    I. R. C. § 61(a) defines gross income broadly to include all income from whatever source derived, unless excluded by law. I. R. C. § 118(a) excludes from gross income any contribution to the capital of a corporation by a nonshareholder, provided such contribution does not constitute payment for goods or services rendered. I. R. C. § 102(a) excludes from gross income the value of property acquired by gift. I. R. C. § 139(a) excludes from gross income any amount received by an individual as a qualified disaster relief payment. I. R. C. § 6662(a) and (b)(2) impose a 20% accuracy-related penalty for a substantial understatement of income tax, but this penalty does not apply if there is substantial authority for the taxpayer’s position.

    Holding

    The grant proceeds received by the petitioner are not excludable from gross income under I. R. C. § 118 as they were not intended to become part of the petitioner’s permanent working capital. The grant proceeds are also not excludable under I. R. C. § 102 as they were not given out of detached and disinterested generosity. Lastly, the proceeds are not excludable under I. R. C. § 139 as this section applies only to individuals and not corporations. The petitioner is not liable for the accuracy-related penalty under I. R. C. § 6662(a) and (b)(2) because there was substantial authority for its position.

    Reasoning

    The court reasoned that for a transfer to be excluded under I. R. C. § 118 as a contribution to capital, it must become part of the permanent working capital of the corporation. The grant proceeds in question were used to reimburse operating expenses (rent) and were not restricted to capital expenditures. The court cited United States v. Chicago, Burlington & Quincy Railroad Co. , 412 U. S. 401 (1973), which established that government payments intended for operational costs are not contributions to capital. The court also found that the grant was not a gift under I. R. C. § 102 because it was not motivated by detached and disinterested generosity but by an expectation of economic benefits to the state, as articulated in Commissioner v. Duberstein, 363 U. S. 278 (1960). The court rejected the application of I. R. C. § 139 as it applies only to individuals. Regarding the penalty, the court found substantial authority for the petitioner’s position in the statutory text of I. R. C. § 118 as it existed in 2007, and in Supreme Court cases such as Edwards v. Cuba Railroad Co. , 268 U. S. 628 (1925), Brown Shoe Co. v. Commissioner, 339 U. S. 583 (1950), and United States v. Chicago, Burlington & Quincy Railroad Co. , 412 U. S. 401 (1973), which supported the petitioner’s good faith argument that the grants were not taxable income.

    Disposition

    The court entered a decision for the respondent as to the deficiency and for the petitioner as to the accuracy-related penalty.

    Significance/Impact

    This case clarifies the tax treatment of government grants post-disaster under I. R. C. §§ 118, 102, and 139. It distinguishes between grants intended as contributions to capital versus those intended to reimburse operational costs, reinforcing the principle that the former may be excluded from income while the latter are taxable. The decision also highlights the importance of the transferor’s intent in determining whether a payment is a gift under I. R. C. § 102. The finding on the accuracy-related penalty underscores the necessity of substantial authority in tax positions, particularly in novel circumstances such as post-disaster economic recovery. Subsequent legislative changes to I. R. C. § 118 in 2017 further delineated the tax treatment of government grants, reflecting the evolving nature of tax law in response to judicial interpretations.

  • Nathel v. Comm’r, 131 T.C. 262 (2008): Treatment of Capital Contributions to S Corporations

    Ira Nathel and Tracy Nathel v. Commissioner of Internal Revenue; Sheldon Nathel and Ann M. Nathel v. Commissioner of Internal Revenue, 131 T. C. 262 (2008)

    In Nathel v. Comm’r, the U. S. Tax Court ruled that capital contributions to S corporations do not restore or increase a shareholder’s tax basis in loans made to the corporation. The Nathels argued that their contributions should be treated as income to the corporations, thereby increasing their loan bases, but the court rejected this, affirming that capital contributions increase stock basis, not loan basis. This decision clarifies the distinction between equity and debt in S corporations and impacts how shareholders calculate taxable income from loan repayments.

    Parties

    Ira Nathel and Tracy Nathel, and Sheldon Nathel and Ann M. Nathel, were the petitioners in these consolidated cases before the United States Tax Court. The respondent was the Commissioner of Internal Revenue.

    Facts

    Ira and Sheldon Nathel, brothers, along with Gary Wishnatzki, organized three S corporations: G&D Farms, Inc. (G&D), Wishnatzki & Nathel, Inc. (W&N), and Wishnatzki & Nathel of California, Inc. (W&N CAL) to operate food distribution businesses. Each Nathel brother owned 25% of the stock in each corporation, while Gary owned 50%. The Nathels made loans to G&D and W&N CAL on open account. In 1999, G&D borrowed approximately $2. 5 million from banks, which the Nathels personally guaranteed. Due to prior losses, by January 1, 2001, the Nathels’ tax bases in their stock and loans in G&D and W&N CAL were reduced to zero and minimal amounts, respectively. On February 2, 2001, G&D repaid the Nathels $649,775 each on their loans. Later that year, disagreements arose between the Nathels and Gary, leading to a reorganization of the corporations. As part of the reorganization, on August 30, 2001, the Nathels made additional capital contributions totaling $1,437,248 to G&D and W&N CAL, and G&D and W&N CAL made further loan repayments to the Nathels.

    Procedural History

    The Nathels treated their August 30, 2001, capital contributions as income to G&D and W&N CAL, thereby increasing their tax bases in the loans to these corporations. This allowed them to offset ordinary income from the $1,622,050 in loan repayments they received in 2001. The Commissioner of Internal Revenue audited their returns and determined that these capital contributions increased the Nathels’ stock basis, not their loan basis, resulting in additional ordinary income from the loan repayments. The Nathels petitioned the U. S. Tax Court, which consolidated the cases for trial and opinion.

    Issue(s)

    Whether, for purposes of I. R. C. § 1366(a)(1), the Nathels’ $1,437,248 capital contributions to G&D and W&N CAL may be treated as income to these corporations, thereby restoring or increasing the Nathels’ tax bases in their loans to the corporations under I. R. C. § 1367(b)(2)(B)?

    Rule(s) of Law

    Under I. R. C. § 118, contributions to the capital of a corporation are not included in the corporation’s gross income. I. R. C. § 1367(a)(1) states that a shareholder’s basis in stock of an S corporation is increased by the shareholder’s share of the corporation’s income items, while § 1367(a)(2) decreases the basis by losses and deductions. If a shareholder’s stock basis is reduced to zero, losses reduce the basis in any loans to the corporation under § 1367(b)(2)(A). A “net increase” in the shareholder’s share of income first restores the basis in loans and then increases the stock basis under § 1367(b)(2)(B).

    Holding

    The Tax Court held that the Nathels’ $1,437,248 capital contributions to G&D and W&N CAL do not constitute income to these corporations and do not restore or increase the Nathels’ tax bases in their loans to these corporations under I. R. C. §§ 1366(a)(1) and 1367(b)(2)(B).

    Reasoning

    The court reasoned that capital contributions to a corporation do not constitute income to the corporation, as established by I. R. C. § 118 and affirmed by long-standing tax principles, including Commissioner v. Fink and Edwards v. Cuba R. R. Co. . The court rejected the Nathels’ reliance on Gitlitz v. Commissioner, which held that discharge of indebtedness income excluded under I. R. C. § 108(a) was treated as income to an S corporation for § 1366(a)(1) purposes. The court distinguished capital contributions from discharge of indebtedness income, noting that the former are not listed as gross income under § 61 and are specifically excluded from income by § 118 and related regulations. The court also found that the Nathels’ contributions were not made solely to obtain release from their loan guarantees, thus not qualifying as deductible losses under I. R. C. § 165(c)(1) or (2).

    Disposition

    The Tax Court entered decisions for the respondent, the Commissioner of Internal Revenue.

    Significance/Impact

    The decision in Nathel v. Comm’r reaffirms the principle that capital contributions to S corporations increase the shareholder’s stock basis but do not affect the basis in loans made to the corporation. This ruling has implications for how shareholders calculate their taxable income from loan repayments from S corporations and underscores the importance of distinguishing between equity and debt in tax law. It also serves as a reminder that capital contributions are not treated as income to the corporation, aligning with longstanding tax principles. The case has been cited in subsequent decisions and tax literature as an authoritative interpretation of the relevant Internal Revenue Code sections concerning S corporations.