Every once in while the taxpayer's planning holds up!
I know that is a little deep for some clients, but struggle through it if you want to read an example of how the IRS doesn't win them all.
Transfer of Property to Employee/Child Is a Gift, Not Compensation
A transfer of property to an employee who is a member of the employer's family is more properly considered a gift when the transfer is not made in recognition of the employee's work, but is made in connection with the family relationship. Caracci v. Commissioner, 118 T.C. No. 25 (5/22/02)
Victor and Joyce Caracci owned three home health care organizations exempt from federal income taxes under Code Section 501(c)(3). In 1996, Victor and Joyce and their children created three S corporations and, collectively, received all the resulting stock. The three home health care organizations then transferred all of their assets to the three S corporations, respectively, in exchange for each S corporation's assumption of the transferor's liabilities. The Caracci children were also employed by the S corporations.
The IRS determined that the fair market value of the transferred assets substantially exceeded the consideration received. Accordingly, the IRS determined that the three S corporations and the Caracci family were liable for excise taxes under Code Section 4958. The IRS also determined that the three home health care organizations failed to qualify for tax-exempt status. Finally, the IRS determined that the Caracci children who received stock in the S corporations but did not have an ownership interest in the three home health care organizations were liable for income taxes on the value of the stock received. According to the IRS, they realized gross income by virtue of the fact that the S corporations, in connection with their organization, received the assets of the tax-exempt organization. The IRS argued that the constructive transfer is an accession to wealth that is includible in the children's' gross income.
The Tax Court held that the value of the transferred assets exceeded the value of the consideration received. Thus, the three S corporations and the Caracci family members were "disqualified persons" subject to excise taxes under Code Section 4958, as beneficiaries of "excess benefit transactions." However, the court found that, although the home health care organizations engaged in excess benefit transactions, a revocation of their tax-exempt status was inappropriate given the intermediate sanctions under Code Section 4958.
With respect to whether the Caracci children who received stock in the S corporations were liable for income taxes on the value of the stock received, the court concluded that they were not. The court rejected the IRS's argument that the transfer resulted in gross income to the Caracci children. Although Code Section 61 provides broadly that gross income includes all income from whatever source derived, the court noted that Code Section 102(a) generally exempts from that provision the value of any property received by gift. When property is transferred for less than adequate and full consideration in money or money's worth, the court observed, the amount by which the value of the property exceeds the value of the consideration is deemed a gift. The court also determined that the fact that the children were also employees of the new S corporations did not transform their receipt of corporate stock into compensation subject to income tax. While Code Section 102(c) provides that the transfer of property to an employee is generally deemed to be compensation, rather than a gift, the court concluded that a transfer of property to an employee who is a member of the employer's family is more properly considered a gift when the transfer is not made in recognition of the employee's work, but is made in connection with the family relationship.
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