IRC section 382 limits the use of NOL carryforwards following an ownership change. Recently the Tax Court, in a case of first impression, had to decide how the family attribution rules applied in a section 382 context.
When they formed Garber Industries Holding Co. Inc., Charles M. Garber Sr. owned 68% and his brother Kenneth R. Garber Sr. owned 19%. In 1996 the corporation underwent a “D” reorganization that reduced Charles’ ownership to 19% and increased Kenneth’s to 65%. In 1998 Kenneth sold his shares of the stock to Charles, giving him a total of 84%. On its 1998 tax return following the sale, Garber Industries used an NOL carryforward to offset current income. The IRS objected on the grounds that the NOL should be reduced pursuant to section 382 because of the deemed ownership change.
Result. For the IRS. Section 382 defines an ownership change as a more than 50% increase in ownership by 5% owners during a three-year period. (A 5% owner is an individual who owns at least 5% of the corporation’s stock either directly or indirectly.)
In determining ownership, section 382 requires the use of the section 318 stock attribution rules, under which a person is deemed to own the stock of his or her family members. Siblings are not considered family, but parents, children and grandchildren are. Section 382 modifies these family attribution rules to treat all family members as one shareholder rather than separate shareholders. Garber Industries Holding Co. argued that although siblings are not related under code section 318(a)(1), they should be treated as a single shareholder headed by their parents or grandparents. The IRS argued that since neither the parents nor grandparents of the taxpayers were alive, the brothers were not one family.
The Tax Court first had to decide whether the code language was ambiguous: It found it sufficiently ambiguous to support the positions of both the taxpayers and the IRS. It turned, therefore, to the legislative history to reach its decision.
Based on that review and prior law, the Tax Court rejected the arguments of both parties. It said the taxpayers’ argument would result in a family that consisted not only of parents, children and grandchildren but also aunts, uncles and cousins—and clearly Congress could not have intended this result. The court rejected the IRS’s argument on the grounds it would make the answer solely dependent on the life or death of the parents and grandparents. This also could not have been Congress’s intent.
Based on its analysis of the code language and the evolution of section 382, the Tax Court concluded the rules applied only to living shareholders. A determination of a family must start with an actual shareholder. To these actual shareholders is added stock owned by their parents, children and grandchildren. As Charles and Kenneth were neither children nor grandchildren of a living shareholder, they did not constitute a family. CPAs should be aware that the decision in this case clarifies the definition of an ownership change and when section 382 will limit the use of NOL carryforwards.
Garber Industries Holding Co. v. Commissioner, 124 TC no. 1.
Prepared by E dward J. Schnee, CPA, PhD, Hugh Culverhouse Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.