Rauenhorst v. Comm’r, 119 T.C. 157 (2002).
Key QSBS Takeaways: A Taxpayer will most likely not be liable for Assignment of Income Doctrine if they transferred the stock in mere anticipation or acknowledgement of a redemption, merger, or the like. It is on the IRS to prove that such agreement (redemption, merger, acquisition, etc.) was ripened to a practical certainty before the gifting occurred.
Question Presented: Whether an anticipatory assignment is triggered when there is a sale on transferred stock that was donated to charitable institutions before a stock warrant was agreed upon?
Sub-Question Presented: Did the Taxpayer’s rights to receive the proceeds of the stock transaction “ripened to a practical certainty” upon the time the stocks were assigned?
Rule:
26 U.S.C.A. § 1202(h)(1), (2): “(h)Certain tax-free and other transfers
For purposes of this section—(1)In general. In the case of a transfer described in paragraph (2), the transferee shall be treated as—(A)having acquired such stock in the same manner as the transferor, and (B)having held such stock during any continuous period immediately preceding the transfer during which it was held (or treated as held under this subsection) by the transferor. (2)Description of transfers. A transfer is described in this subsection if such transfer is—(A)by gift…”
Main QSBS Issues Addressed:
Under Section 1202(h)(2)(A), a holder of QSBS may transfer their QSBS to a donee by a gift. This “tax-free” transaction allows the Donor to carry-over their holding period to the Donee and the Donee accepts such stock in the same manner as the Donor acquired it. However, if the IRS believes such a transaction was anticipatory, the transaction will be taxed accordingly.
Circumstance:
Arbeit assigned the rights to purchase 772.14 shares of NMG Class A common stock (for $1 per share) to four donee organizations, leaving only 2.14 shares assigned to Arbeit—just 7 days before acquisition of NMG, Inc. by World Color Press, Inc. (WCP). WCP then bought the reissued warrant from the four donee organizations and Arbeit for $7, 598.48 per share. IRS claims that this was an anticipatory assignment of income requiring Rauenhorst to report gain on the sale of warrants for their 1993 tax return.
“Arbeit’s sole purpose was to act as a nominee for petitioners, as trustee of the Gerald Rauenhorst Revocable Trust. This trust was a revocable grantor trust, and its assets were treated as owned by Mr. Rauenhorst under sec. 676.”
Rauenhorst v. Comm’r, 119 T.C. 157, 183 n.2 (2002).
Facts:
March 1992: Arbeit and NMG, Inc. created an agreement that required Arbeit to surrender 2,500 NMG series A preferred stock shares. Subsequently, NMG created a promissory note and warrant which gave Arbeit 772.14 shares of NMG class A common stock for $1 per share.
September 1993: World Color Press, Inc. (WCP) executed a letter of intent to directors of NMG, Inc. showing interest in purchasing all the issued and outstanding shares of NMG.
November 9, 1993: Arbeit assigned its rights in the NMG warrant from March 1992 (for 772.14 NMG shares) to four donee organizations defined under 26 U.S.C.A. § 170(C)(2).
November 15, 1993: GM of Arbeit sent a letter to both NMG and WCP surrendering its warrant to purchase 2.14 shares as part of WCP’s acquisition of NMG as discussed in September 1993.
Side Note: Notice how the other 770 shares of NMG class A common stock was not a part of Arbeit’s letter. As stated before, Arbeit only had a right to 2.14 shares after assigning the rights to the other 700 shares to the four donee organizations.
November 22, 1993: After legal counsel for NMG requested the donee organizations to sell its reissued warrant to WCP; NMG’s stockholders, and WCP executed a purchase agreement for all issued and outstanding stock of NMG for $31 million. Transaction closed by December 22, 1993, and the price per share was $7, 598.48.
November 18, 1999: IRS issued a notice to Rauenhorst for deficiency of $1,322,295 in federal taxes from failing to report any gain from the sale of the warrants by the donees on 1993 tax return. IRS claimed the donation of NMG stock was an anticipatory assignment of income, which resulted an increase in capital gains for the amount of $4,722,484 back in 1993.
Analysis:
Anticipatory assignment of income doctrine was created in order for the Commissioner to be able to recharacterize a taxpayer’s purported gift of appreciated property. The legal system has had many years to analyze the doctrine and stated,
“‘the mere assignment of the right to receive income is not enough to insulate the assignor from income tax liability’ where ‘the assignor actually earns the income or is otherwise the source of the right to receive and enjoy the income.’”
Rauenhorst v. Comm’r, 119 T.C. 157, 163 (2002) (quoting Commissioner v. Sunnen, 333 U.S. 591, 604 (1948).
However, the courts throughout many decades have decided that a donor can anticipate or even be aware of a redemption in the immediate future. The presence of an actual gift which is absent of any obligations (such as legally obligated to redeem) will give the gift “independent significance.” Id. at 164 (citing Sunnen, 333 U.S. at 693); see DeWitt v. United States, 503 F.2d 1406 (Ct.Cl.1974); and Sheppard v. United States, 176 Ct.Cl. 244 (1966).
The Commissioner of Internal Revenue argues that Rev. Rul. 78-197, 1978-1 C.B. 83 is not controlling law. However, the Tax Court goes on to state the Comissioner has “neither revoked nor modified Rev. Rul. 78–197, supra, in response to the comments in Blake. Indeed, the Commissioner has continued to rely on Rev. Rul. 78–197, supra, in issuing his private letter rulings.” Rauenhorst v. Comm’r, 119 T.C. 157, 170 (2002); See, e.g., Priv. Ltr. Rul.2002–30–004 (July 26, 2002). The Revenue Ruling discussed that the IRS should only treat redemption proceeds as Donor income if the donee is legally bound or could be compelled by the corporation to give up such donated shares for said redemption. Subsequently, the court denied the argument that the Commissioner could not be bound to follow Revenue Rulings in Tax Court proceedings.
Concluding, the Tax Court relied on the question whether or not the charitable donees were legally bound to sell their reissued stock warrants at the time Arbeit assigned such rights on November 9, 1993. The court states that the letter of intent in September 1993 was just a mere confirmation of WCP’s intent to purchase all of NMG, Inc. shares. Even if the NMG board of directors accepted the letter of intent, it does not legally bind NMG to the proposal because the letter was not to be considered as an offer.
Ruling, Rev. Rul. 78-197, 1978-1 C.B. 83 was contrary to the Commissioner of Internal Revenue’s arguments; therefore, the defendants were not legally bound to WCP’s intent to acquire NMG and the assigned rights of stock warrants to four charitable organization—just 7 days before closing transaction of acquisition—was not considered to be an assignment of income.
Court Ruling:
“Under the circumstances of this case, we treat the Commissioner’s position in Rev. Rul. 78–197, 1978–1 C.B. 83, as a concession. Accordingly, our decision is limited to the question whether the charitable donees were legally obligated or could be compelled to sell the stock warrants at the time of the assignments.”
Rauenhorst v. Comm’r, 119 T.C. 157, 173 (2002); see Rev. Rul. 78–197, 1978–1 C.B. 83
Procedure:
United States Tax Court, No. 1982-00, October 7, 2002.
Citation:
Rauenhorst v. Comm’r, 119 T.C. 157 (2002).
View the case here.
This article does not constitute legal or tax advice. Please consult with your legal or tax advisor with respect to your particular circumstance.