REVISED MARCH 18, 2009
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT United States Court of Appeals
Fifth Circuit
FILED
March 13, 2009
No. 08-60284
Charles R. Fulbruge III
Clerk
LINDA K MINTON
Appellant
v.
COMMISSIONER OF INTERNAL REVENUE
Appellee
Appeal from a Decision of
the United States Tax Court
Before JONES, Chief Judge, JOLLY, Circuit Judge, and CARDONE,* District
Judge.
PER CURIAM:
In this appeal from the Tax Court, Linda Minton argues that a transaction
among her, her parents, and her brother, all of whom were shareholders of
Long’s Preferred Products, Inc., created a second class of stock thereby
terminating the company’s status as a small business corporation. The Tax
Court determined that the transaction did not create a second class of stock, and
the court sustained the deficiency assessed against Minton. We agree with the
Tax Court’s determination and affirm its judgment.
*
United States District Judge of the Western District of Texas, sitting by designation.
No. 08-60284
I.
A.
Generally the income of a corporation is taxed twice, once at the corporate
level and again at the shareholder level when the money is distributed as
dividends. A small business corporation, however, may avoid this onerous
double taxation by electing to be an S corporation (“S-corp”). Gitlitz v. Comm’r,
531 U.S. 206, 209 (2001). An S-corp, as a pass-through entity, does not have to
pay income tax. I.R.C. § 1363(a). Instead, each shareholder must pay tax on his
pro rata share of the corporate profits. Id.§ 1366(a)(1); Gitlitz, 531 U.S. at 209;
Nail v. Martinez, 391 F.3d 678, 681 (5th Cir. 2004).
Only corporations that conform to the Internal Revenue Code’s definition
of a “small business corporation” may elect to be an S-corp. The Code’s definition
limits small business corporations to those corporations that, among other
characteristics, have only one class of stock. I.R.C. § 1361(b)(1)(D). If an S-corp
issues a second class of stock, it ceases to fit the definition of a small business
corporation, and its S-corp status is automatically terminated. Id.
§ 1362(d)(2)(A).
B.
Long’s Preferred Products, Inc. (“LPP”) is a family-owned janitorial and
paper-supply company. Julian E. Long (“Julian”) and his wife Alma Long
started LPP in the 1950s and incorporated the business in 1976. Soon after its
incorporation, LPP sought and received S-corp treatment. At the time, Julian
and Alma were the sole owners of LPP’s one hundred outstanding shares. As
Julian and Alma aged, their children, Julian W. “Dooksie” Long (“Dooksie”) and
Linda Minton, gradually took control of the company. In 1986, Minton and
Dooksie each supposedly purchased nineteen shares from their parents. Minton
asserts that in exchange for these shares Alma and Julian received monthly
distributions from LPP. Julian and Alma initially received $4,000 per month,
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No. 08-60284
but the amount was reduced to $2,000 when Alma died in 1990. There are no
executed documents reflecting any of these transactions.
By 1996, through purchase, gift, and bequest, Julian and Alma had
relinquished all of their shares to the children, and Minton and Dooksie each
owned a 50% interest in LPP. In 1997, a dispute arose. Minton and Dooksie
determined that one would have to buy the other out. When the negotiations
broke down, Julian and Dooksie attempted to squeeze Minton out. Minton then
sued in Louisiana state court to establish her 50% ownership.1 Julian and
Dooksie argued that the alleged 1986 sale was merely an inchoate plan to evade
Alma’s creditors. The sale, they asserted, never actually took place. Under this
view, Julian still owned nineteen LPP shares, and he and Dooksie collectively
owned substantially more shares than Minton. Minton vigorously asserted that
the transaction had in fact taken place and that her father no longer owned any
shares. But she was unable to produce any of the purported transaction
documents.2 The evidence was weak on both sides, but the court found Minton’s
testimony to be more credible than Dooksie’s and declared that Minton owned
half of LPP.
During the course of the litigation, Minton’s counsel discovered an audio
recording of a 1986 shareholder meeting.3 From this recording, he concluded
that the monthly distributions to Julian and Alma constituted a preferential
distribution of LPP’s income, not a purchase payment for their stock by Minton
and Dooksie. Minton’s counsel concluded that this preferential distribution
created a second class of stock and automatically terminated LPP’s S-corp
status. If LPP’s S-Corp election was terminated, then LPP was no longer a pass-
1
See Minton v. Long's Preferred Prods., Inc., 2008 WL 241543 (La. Ct. App. Jan. 30,
2008).
2
At some point, Julian produced the original promissory note, but it was unsigned.
3
The recording is not in the record; we have only an unauthenticated transcript.
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No. 08-60284
through entity. Minton therefore personally owed no taxes on LPP’s profits, but
only owed taxes on money actually distributed to her by the company. Upon her
counsel’s recommendation, Minton did not report her share of LPP income on her
1998 tax return, and she filed amended returns for 1996 and 1997.
Soon thereafter, a revenue agent conducted an investigation and concluded
that the monthly distributions did not evidence a second class of stock. Thus,
LPP was still an S-corp, and Minton owed taxes on her share of the income. The
IRS assessed a deficiency of $165,366, and Minton petitioned the Tax Court for
a redetermination.4
C.
In the Tax Court, Minton continued to assert that the 1986 transaction
terminated LPP’s S-corp status.5 To make her argument she addressed
Treasury Regulation § 1.1361-1. Subsection (l)(1) of that regulation states that
“a corporation is treated as having only one class of stock if all outstanding
shares of stock of the corporation confer identical rights to distribution and
liquidation proceeds.” Furthermore,
[t]he determination of whether all outstanding shares
of stock confer identical rights to distribution and
liquidation proceeds is made based on the corporate
4
The deficiency originally included taxes owed on income from Master Distributors,
Inc., another S-corp owned by Minton and Dooksie. The parties settled this issue before trial.
5
Because shareholders usually fare better under a pass-through regime, it is unusual
to find a shareholder arguing that the corporation in which he owns stock has lost its S-corp
status. The following explains Minton’s unusual position in this case. In most years, even
though LPP retained nearly all of its earnings, it would make distributions to each shareholder
sufficient to pay the taxes incurred by the shareholder as a result LPP’s income. In 1998,
however, LPP stopped making tax-payment distributions. Also in 1998, LPP made an
accounting adjustment resulting in a reported income that was significantly higher than
normal. Thus, Minton faced an abnormally high tax liability, and LPP was not making
distributions to cover that liability.
At oral argument, Minton’s counsel suggested that the cessation of tax-payment
distributions is a common tactic used to squeeze out unwanted shareholders. Whether
Minton’s rights as a shareholder are being abused has no bearing on the issue before us.
4
No. 08-60284
charter, articles of incorporation, bylaws, applicable
state law, and binding agreements relating to
distribution and liquidation proceeds (collectively, the
governing provisions).
Treas. Reg. § 1.1361-1(l)(2)(i) (emphasis added). Citing these two provisions,6
Minton argued that the 1986 transaction constituted a binding agreement
regarding distribution and liquidation rights and the distributions to Julian and
Alma were indicative of a second class of stock. The Tax Court was not
persuaded and concluded that Minton failed to prove that the 1986 transaction
constituted a binding agreement providing Julian and Alma disproportionate
distribution rights. Specifically, the court found that there was no evidence that
the directors of LPP took any formal corporate action sufficient to bind the
company in a manner that affected distribution and liquidation rights of the S-
Corp.
Alternatively, the court found that, even if the 1986 transaction
constituted a “binding agreement,” Minton failed to establish that the
distributions were payments to Julian and Alma qua shareholders. The court
thought it was more likely that the distributions were made on behalf of Dooksie
and Minton on account of the debt they incurred by purchasing the shares in
1986. This conclusion was supported by Minton’s state court testimony and
affidavit, in which she stated that the monthly payments to her parents were
made on her behalf through LPP.
II.
We review a Tax Court decision the same as we review a district court
decision: findings of fact are reviewed for clear error and issues of law are
reviewed de novo. Green v. Comm’r, 507 F.3d 857, 866 (5th Cir. 2007).
6
Despite relying upon § 1.1361-1(l)(2)(i) in the Tax Court, Minton now asserts that it
does not apply. See Part II-B, infra.
5
No. 08-60284
A.
We find no error in the Tax Court’s conclusion that Minton did not carry
her burden of proving that the 1986 transaction constituted the creation of a
second class of LPP stock.7 Like the state court and the Tax Court, we must
observe that there is very little evidence from which to discern the nature and
form of the transaction. This factor works against Minton, who has the burden
of proof. Minton’s only evidence is her own testimony and LPP’s distribution
records from 1993 to 1998. This evidence demonstrates only that the parents
received monthly distributions from LPP. It tells us nothing of the form of the
transaction. The parties could have implemented a transfer of the shares from
the parents to the children resulting in a fixed monthly payment to the parents
in any number of ways. It is conceivable, although unlikely, that the parties
could have structured the transaction in a manner that bound LPP to distribute
a preferred stream of income to the parents; there is, however, no evidence that
the transaction took this form. We agree with the Tax Court’s conclusion that
the evidence as a whole suggests that it is more probable that the transaction
was structured in a way that neither formally nor legally bound LPP. To be
sure, Minton’s testimony in the Louisiana litigation suggested that she and
Dooksie purchased the shares directly and the monthly payments by LPP were
simply made on their behalf.
If the burden of proof were on the Commissioner, our conclusion may not
be as certain. But Minton bears the burden, and we find no error in the Tax
Court’s conclusion that she failed to carry it.
B.
Minton also asserts that the Tax Court erred by applying Treasury
Regulation § 1.1361-1(l). That subsection applies to tax years and transactions
7
Tax Court Rule 142(a) provides that the burden of proof is on the petitioner.
6
No. 08-60284
occurring after 1992. Treas. Reg. § 1.1361-1(l)(7). A corporation and its
shareholders, however, may elect to apply the regulation to tax years prior to
1992. Id. The Tax Court implied such an election by Minton’s reliance upon the
regulation in her arguments. Both Minton and the Commissioner agree that the
Tax Court erred by implying such an election. We also agree that the regulation
is inapplicable despite Minton’s reliance upon it in the Tax Court. The provision
only permits the retroactive application of the regulation to prior tax years, not
prior transactions.8
Nonetheless, the error is harmless because, as we stated earlier, the
evidence is not convincing that the 1986 transaction created a second class of
stock.
III.
For the reasons given, we find no error in the Tax Court’s conclusion that
Minton failed to carry her burden of proof. The judgment of the Tax Court is
therefore
AFFIRMED.
8
“[A] corporation and its shareholders may apply this § 1.1361-1(l) to prior taxable
years. Treas. Reg. § 1.1361-1(l)(7).
7