Garber Industries, Inc. v. Commissioner
2006 U.S. App. LEXIS 508, 435 F.3d 555, 97 A.F.T.R.2d (RIA) 429 (2006)
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Rule of Law:
Under I.R.C. § 382, a sale of stock between siblings that results in a more than 50 percentage point shift in ownership constitutes an 'ownership change,' limiting the corporation's use of net operating loss carryforwards, because siblings are not included in the statutory definition of 'family' for stock aggregation purposes.
Facts:
- Brothers Charles M. Garber and Kenneth R. Garber were the primary shareholders of Garber Industries Holding Co., Inc.
- By the end of 1997, Garber Industries had accumulated net operating loss (NOL) carryforwards exceeding twenty million dollars.
- Following a corporate reorganization in 1996, Charles Garber owned 19% of the company's stock, and Kenneth Garber owned 65%.
- In April 1998, Kenneth Garber and his wife sold all of their shares, representing 65% of the company, to Charles Garber.
- As a result of this transaction, Charles Garber's ownership interest in the company increased from 19% to 84%.
Procedural Posture:
- The Internal Revenue Service (IRS) audited Garber Industries' 1997 and 1998 corporate tax returns.
- In June 2001, the Commissioner of the IRS issued a Notice of Deficiency to Garber Industries, determining that an ownership change had occurred and limiting the company's deduction of net operating loss carryovers.
- Garber Industries filed a petition in the U.S. Tax Court (court of first instance) to challenge the deficiency.
- The U.S. Tax Court ruled in favor of the Commissioner, holding that the stock sale between the brothers constituted an ownership change under § 382.
- Garber Industries (Petitioner-Appellant) appealed the Tax Court's decision to the U.S. Court of Appeals for the Fifth Circuit.
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Issue:
Does a sale of a controlling block of corporate stock between two brothers constitute an 'ownership change' under I.R.C. § 382, thereby limiting the corporation's ability to deduct net operating loss carryforwards?
Opinions:
Majority - W. Eugene Davis
Yes, the sale of stock between the brothers constitutes an 'ownership change' under I.R.C. § 382. An 'ownership change' occurs when a 5% shareholder's ownership increases by more than 50 percentage points within a three-year testing period. Here, Charles Garber's ownership increased by 65 percentage points (from 19% to 84%), clearly satisfying this threshold. The taxpayer's argument that the brothers' stock should be aggregated fails because the family attribution rules in § 382 incorporate the narrow definition of 'family' from § 318(a)(1), which includes only an individual's spouse, children, grandchildren, and parents. Siblings are not on this list. The court rejected the argument for 'double attribution' (from Kenneth to a non-shareholder parent and then to Charles), holding that § 382's language creates a simple family grouping model that wholly replaces the more complex attribution rules of § 318. The analysis must begin with an actual shareholder, and since the brothers are not considered a single individual under the statute, the sale between them is treated as an owner shift triggering the NOL limitation.
Analysis:
This decision reinforces a strict, literal interpretation of the family aggregation rules under I.R.C. § 382. It clarifies that courts will not expand the statutory definition of 'family' to include siblings or permit creative attribution theories, such as using a non-shareholder parent as a link. The case provides a clear warning to family-owned businesses that intra-family stock transfers, even between close relatives like siblings, can have significant adverse tax consequences if they cross the 50 percentage point ownership change threshold. This holding solidifies the principle that tax statutes are to be applied as written, prioritizing statutory text over broader notions of family unity.
