Capital gain tax on disputed sale in shareholder’s forced buyout

Tax problem with capital gain taxes, S Corp capital gain tax problem

Ninth Circuit holds that gain was recognized on disputed sale in shareholder’s forced buyout

Glenn Hightower v. Comm., (CA9 2/12/2008)

The Court of Appeals for the Ninth Circuit, affirming the Tax Court’s decision, has held that an individual who had been a 50% co-owner of an S corporation and who effectively was ousted by the other owner had to recognize gain on the forced sale of his stock in the year he received payment for it. This was so even though he continued to dispute the forced buyout in state courts after the payment was made.

Facts. Glen Hightower and Daniel O’Dowd each owned 50% of the stock of an S corporation known as Green Hills Software, Inc. Their shareholders’ agreement provided that any dispute between them would be resolved through binding arbitration and either of them could compel a buyout of the other’s stock at a formula price.

Relations between the two co-owners eventually deteriorated to the point that in ’98 O’Dowd triggered the buy/sell provision of the shareholders’ agreement by offering either to sell his shares to Hightower for $47 million or to buy Hightower’s shares for that amount. Although Hightower didn’t want to sell his stock, he couldn’t obtain financing to buy O’Dowd’s stock for $47 million. Accordingly, O’Dowd compelled a buyout of Hightower’s stock.

Hightower demanded arbitration regarding O’Dowd’s buyout, but the arbitrator ruled in O’Dowd’s favor. Hightower received a check from O’Dowd in 2000 for $41,585,388, which Hightower deposited into an interest bearing account. Hightower, who used the cash method, didn’t report this payment or any interest on it on his return. When Hightower later sought to have the arbitration award set aside in state court, he lost. He appealed all the way to the state’s top court, which in 2003 declined to hear his case.

Tax Court’s decision. The Tax Court, rejecting a wide variety of taxpayer’s arguments, held that Hightower recognized gain on the forced sale of his stock in 2000, the year he received payment for it. The Tax Court found that Hightower wasn’t holding O’Dowd’s payment in trust in a segregated account nor had he involuntarily received the funds and unconditionally renounced his right to them by creating a separate account. Hightower, who voluntarily cashed the check for the payment, intended to return the funds only if he succeeded in rescinding O’Dowd’s buyout. The Tax Court rejected his argument that the sale was incomplete because he tendered his shares without endorsing the certificates, noting that the arbitrator and state courts found that Hightower’s stock was purchased in 2000. The Tax Court concluded that even if payment to Hightower violated state law, a later determination to that effect wouldn’t absolve him from his tax liability in the year of the receipt. Further, the gain did not escape tax, as Hightower argued, under the claim of right doctrine–under which a payment is includable in income in the year in which a taxpayer receives it under a claim of right (even if that claim is disputed by another party) and without restriction as to its disposition.

Ninth Circuit finds forced sale resulted in gain. The Ninth Circuit held that the stock payment Hightower received for his share of Green Hills was taxable income in 2000 because it was received without restriction as to its disposition and because he had no fixed legal obligation to restore the funds to any other party. This conclusion wasn’t altered by the possibility that the stock transaction could have later been unwound by a state court. Hightower’s unilateral intent not to claim and exercise dominion over the funds didn’t affect his tax liability. Similarly, for federal tax purposes, it was irrelevant that the transaction may have left Green Hills with a negative net worth in violation of state law. Further, because the stock payment was taxable income to Hightower in 2000, the interest which accrued on the principal was also taxable income in the year the interest was received.

The Court also held that Hightower had to report the pass-through distributive share of Green Hills’s income allocated to him in 2000. Even though Hightower’s role in Green Hills management may have been restricted, he still retained beneficial ownership of his shares through the sale date. The arbitration award didn’t have the effect of divesting him of beneficial ownership of his Green Hills shares in ’98, as Hightower claimed. Rather, it merely gave O’Dowd the financial benefit of the bargain retroactively once the sale took place in 2000.

Mike Habib, EA
myIRSTaxRelief.com

Client Reviews
★★★★★
Mike has given us peace of mind! He helped negotiate down a large balance and get us on a payment plan that we can afford with no worries! The stress of dealing with the IRS is huge and Mike helped us through it all. The peace of mind is invaluable, thank you Mike!April S.
★★★★★
Mike Habib - Thank you for being so professional and honest and taking care of my brothers IRS situation. We are so relieved it is over and the offer in compromise process went just as you said. Mike is very professional and will give you honest answers to the OIC process and you can really trust him. You won't be sorry you chose him!Joe and Deborah V.
★★★★★
Mike is a true professional. He really came thru for me and my business. Dealing with the IRS is very scary. I'm a small business person who works hard and Mike helped me see that they are not that scary after all. He was always there with the answers I needed and was very good about calling me back which I appreciated since your first reaction is to freak out and ask a million questions. He solved a messy case and worked very hard to resolve it. His rates are VERY reasonable for the amount of work he does! I give him my highest recommendation!Marcie R.
★★★★★
Mike was incredibly responsive to my IRS issues. Once I decided to go with him (after interviewing numerous other tax professionals), he got on the phone with the IRS immediately (as in the same day I signed with him) to squash an impending issue. And he worked directly with them to quickly come to a resolution I am very happy with. I'd highly recommend reaching out to Mike to see if he can help you with any IRS issues. I'm very satisfied!Marshall W.
★★★★★
I’ve seen and heard plenty of commercials on TV and radio for businesses offering tax help. I did my research on many of them only to discover numerous complaints and unresolved tax issues. I found Mike Habib through my own online search and contacted him. He was very professional with great communication, always answering my questions and concerns. Mike resolved my complicated tax problem just as he said he would. I would definitely recommend his services to family and friends.Nancy & Sal V.

BBB Accredited Business
Trust Link
California Society of Enrolled Agents
NAEA
NATP
Enrolled Agent