Taxpayer gifted shares of privately held JAM Pharmaceutical, Inc., (“JAM” or the “Company”) to his son. He also executed a purchase agreement with son to purchase a 95% interest in the Company. However, Taxpayer failed to comply with the terms of the purchase agreement, received distributions in excess of his basis in the stock, and faced a significant long-term capital gain tax liability as a result.
The Takeaway Interestingly, the court indicated “the parties do no argue that disproportionate distributions from JAM created a second class of stock for purposes of section 1361(b),” which is prohibited in an S corporation such as JAM. Even so, the Taxpayer argued that an example presented in IRC § 1.1361-1(1)(2)(vi) provided evidence that his disproportionate distribution was exempt from taxation. However, the IRC example had facts substantially different from the case at hand and the Taxpayer provided no evidence that “corrective distributions” (as shown in the example) were made by JAM. Hence, the court disallowed the Taxpayer’s argument.