You Can’t Take It With You When You’ve Already Given It Away

If I give my brother $100, do I still have that $100? Of course not: My brother has that. The same holds true for any gift I give him; that property is now his and I have to live with the consequences of that gift. Today, the Tax Court looked at a situation where an individual gave a gift but said he hadn’t done so.

The Tax Court noted the issue quite well: “The issue for decision is whether distributions petitioner received from an S corporation exceeded his adjusted basis in the corporation’s stock.” This is an issue of basis, and basis remains one of the most troubling concepts for the lay person in tax.

Basically, your basis in something is what you paid for it less whatever you’ve taken out of it. For an S Corporation, there are two bases: stock (capital) and loan. If you take distributions in excess of basis, you have a taxable distribution.

In this case, the taxpayer signed a purchase agreement with his son to sell his son some of the stock of the business in 2002. The business had two classes of stock, and some of each kind was sold to the son. However, the son didn’t pay for it; instead, it apparently was given to his son (with a Gift Tax Return being filed for the year in question).

The IRS examined the taxpayer’s return and found that the taxpayer had distributions in excess of basis in 2003. The Court had to determine whether there was or wasn’t basis and, therefore, whether or not there was or wasn’t a taxable distribution.

The Court began by noting the obvious:

[W]hile a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not.

The gift of the stock was noted on the 2002 Gift Tax Return, and that really was the case.

Today, I had a client call me wondering whether or not he could take a distribution from an S Corporation without having basis. I told him he could, but he’d have a taxable gain. Just ten minutes later, I read this case. Hopefully he’ll get the idea that if you don’t have basis, you do have a gain if you take a distribution.

Case: Milller v. Commissioner, T.C. Memo 2011-189

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