Wiebusch v. Commissioner
59 T.C. No. 76, 1973 U.S. Tax Ct. LEXIS 163, 59 T.C. 777 (1973)
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Rule of Law:
Under IRC § 357(c), a taxpayer recognizes taxable gain on a § 351 transfer of property to a corporation to the extent that liabilities assumed by the corporation exceed the taxpayer's adjusted basis in the property. This gain recognition and liability assumption reduces the shareholder's stock basis under § 358, which can limit the deductibility of the S corporation's losses under § 1374(c)(2).
Facts:
- George W. Wiebusch and Corinna Jane Wiebusch operated a ranching business as a sole proprietorship.
- On January 2, 1964, they transferred the assets of the business to a newly formed corporation, Wiebusch Land & Cattle Co. (L & C), in exchange for its stock.
- The total adjusted basis of the transferred assets was $119,219.08.
- As part of the exchange, L & C assumed liabilities of the ranching operation totaling $180,441.33.
- The liabilities assumed by the corporation exceeded the adjusted basis of the assets by $61,222.25.
- L & C elected to be taxed as a small business corporation under Subchapter S of the Internal Revenue Code.
- For the years 1964, 1965, and 1966, L & C incurred significant net operating losses.
Procedural Posture:
- The Commissioner of Internal Revenue determined deficiencies in the Federal income tax of George and Corinna Wiebusch for the calendar years 1964, 1965, and 1966.
- The Wiebuschs, as petitioners, challenged the Commissioner's determination by filing a petition in the United States Tax Court.
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Issue:
Does a taxpayer who transfers assets and liabilities to a new S corporation under § 351 (1) recognize taxable gain under § 357(c) to the extent the liabilities exceed the assets' adjusted basis, and (2) consequently have their stock basis reduced to zero, thereby precluding the deduction of corporate net operating losses under § 1374(c)(2)?
Opinions:
Majority - Sterrett, J.
Yes. A taxpayer must recognize gain under § 357(c) when liabilities assumed exceed the adjusted basis of the property transferred, and the resulting calculation under § 358 reduces the shareholder's stock basis to zero, precluding any deduction of the corporation's subsequent losses under § 1374(c)(2). The court first held that § 357(c) is constitutional, rejecting the petitioners' argument that it unfairly treats debtor and non-debtor taxpayers differently. The court found it reasonable for Congress to choose the moment of incorporation to tax the 'inherent tax benefit' created by the excess liabilities, which often results from prior tax benefits like depreciation. The court then applied the basis calculation formula of § 358: the shareholder's stock basis begins with the adjusted basis of the property transferred ($119,219.08), is decreased by the liabilities assumed ($180,441.33), and is increased by the gain recognized under § 357(c) ($61,222.25). This calculation resulted in a stock basis of zero. Finally, the court applied § 1374(c)(2), which limits an S corporation shareholder's deduction of corporate losses to the sum of their basis in the stock and any indebtedness of the corporation to the shareholder. Because the Wiebuschs' stock basis was zero and there was no corporate indebtedness to them, they were not entitled to deduct any portion of the corporation's losses on their personal income tax returns.
Analysis:
This case serves as a foundational warning about the mechanical and often unforgiving nature of corporate tax provisions, particularly the interplay between § 351, § 357(c), § 358, and Subchapter S rules. It solidifies the principle that incorporating a business with liabilities in excess of the assets' basis is a taxable event, not a fully tax-free exchange. The decision demonstrates how this initial gain recognition has a direct and potentially detrimental downstream effect on a shareholder's stock basis, which in turn can eliminate the primary benefit of an S corporation election: the pass-through of losses. It underscores the critical importance of pre-incorporation tax planning to avoid what the court famously termed a 'bitter trap for the unwary.'
