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Full Opinion
United States Court of Appeals
Fifth Circuit
F I L E D
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT January 9, 2006
Charles R. Fulbruge III
Clerk
No. 05-60142
GARBER INDUSTRIES, INC.,
Petitioner - Appellant,
versus
COMMISSIONER OF INTERNAL REVENUE,
Respondent - Appellee.
--------------------
Appeal from a Decision
of the United States Tax Court
--------------------
Before DAVIS, SMITH and DENNIS, Circuit Judges.
W. EUGENE DAVIS, Circuit Judge:
Petitioner Garber Industries Holding Co., Inc. appeals the
order of the Tax Court limiting the company’s deduction of net
operating loss carryforwards and assessing a deficiency. Because
we agree that the 1998 stock sale from Kenneth Garber to his
brother Charles Garber resulted in an “ownership change” to
Garber Industries under § 382 of the Internal Revenue Code, the
deduction of the loss carryforwards was properly limited and the
judgment of the Tax Court is affirmed.
I.
Garber Industries Holding Co., Inc. (“Garber Industries”)
was incorporated in December 1982. Charles M. Garber owned
3,492.85 shares (68%) of the stock and his brother Kenneth R.
Garber owned 1,312 shares (26%). The remaining shares were owned
by siblings, spouses or children of the two main shareholders.
Garber Industries suffered operating losses from 1983 to 1989 and
again in 1992. Under I.R.C. § 172 net operating losses (“NOLs”)
could be carried forward and deducted. At the end of 1997, the
balance of NOL carryforwards was over twenty million dollars.
In July 1996, Garber Industries undertook a reorganization
under I.R.C. § 368(a)(1)(D). As a result of the reorganization,
Charles Garber’s ownership interest decreased from 68% to 19% and
Kenneth Garber’s ownership interest increased from 26% to 65%.
The remaining ownership of the company remained unchanged.
The critical transfer with respect to this case occurred in
April 1998 when Kenneth Garber and his wife sold all of their
shares of Garber Industries stock (65%) to Charles Garber.
Charles Garber’s ownership interest increased from 19% to 84%.
No other Garber Industries’ stock changed ownership in that year.
On its 1998 return, Garber Industries deducted a net
operating loss carryover of $808,935. The IRS audited the
taxpayer’s 1997 and 1998 returns and determined that the company
had undergone an ownership change under section 382 as a result
of Kenneth’s stock sale to Charles in 1998. Under the Internal
Revenue Code, an ownership change limits the amount of NOL
carryover that can be deducted. As applied to Garber Industries,
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an ownership change would limit the NOL deduction to $121,258.
In June 2001, the Commissioner issued a Notice of Deficiency
resulting from the reduction in the amount of allowable deduction
of net operating loss.
Garber Industries challenged the deficiency in the Tax
Court. The parties settled all issues except those relating to
the 1998 stock sale. It was agreed that if Kenneth’s sale did
not constitute an ownership change, the 1998 NOL carryover would
be allowed in full and the tax deficiency for 1998 would be
$5,070. The parties also agreed that if the sale did constitute
an ownership change, the tax deficiency for 1998 would be
$311,188. The Tax Court ruled in favor of the Commissioner and
held that sale between the brothers did constitute an ownership
change thus limiting the deductibility of the NOL carryforwards
and creating a larger tax deficiency for Garber Industries.
Garber Industries appeals.
II.
The sole issue in this case is whether an ownership change
occurred in relation to Garber Industries, as a result of the
1998 stock sale from Kenneth to Charles Garber, which triggers a
limitation in the deduction of NOL carryforwards by the
corporation under § 382 of the Internal Revenue Code. Whether an
ownership change occurred depends on whether ownership of
Kenneth’s and Charles’ Garber Industries stock can be aggregated
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or attributed to each other under the ownership rules set forth
in §§ 382 and 318. If the brothers’ stock can be aggregated or
its ownership attributed to each other, then a sale between them
does not cause an ownership change.
The purpose of section 382 is to prevent trafficking in net
operating loss carryovers, which in the absence of a limitation
may ordinarily be carried forward for 20 years. The statute
limits the use of NOL carryovers by the “new loss corporation” -
the corporation possessing the losses after an ownership change.
26 U.S.C. § 382(a). An ownership change occurs if, immediately
after an “owner shift” or “equity structure shift,” the
percentage of stock owned by one or more shareholders owning 5%
or more of the corporation (“5% shareholder”) has increased by
more than 50 percentage points over the lowest percentage of
stock owned by such persons during the testing period. 26 U.S.C.
§ 382(g)(1), (k)(7). The testing period is the three year period
ending on the date of the owner shift or equity structure shift.
26 U.S.C. § 382(i). An owner shift is any change in corporate
ownership affecting the percentage of stock owned by a 5%
shareholder. 26 U.S.C. § 382(g)(2).
Both Kenneth and Charles Garber were 5% shareholders. In
the absence of an exception or modification to the above rules,
the 1998 stock sale from Kenneth to Charles clearly caused an
owner shift or ownership change because the sale caused the
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ownership of Charles Garber to increase by more than 50
percentage points (from 19% to 84%).
In some circumstances, § 382 allows stock owned by family
members to be grouped together for purposes of determining
whether an ownership change occurred. To determine ownership of
stock under § 382, the statute refers to the constructive
ownership rules of § 318, with certain modifications. Subsection
(l)(3)(A) of section 382 states -
(l) Certain additional operating rules. For purposes of
this section--
(3) Operating rules relating to ownership of stock.
(A) Constructive ownership. Section 318
(relating to constructive ownership of stock)
shall apply in determining ownership of
stock, except that--
(i) paragraphs (1) and (5)(B) of section
318(a) shall not apply and an individual
and all members of his family described
in paragraph (1) of section 318(a) shall
be treated as 1 individual for purposes
of applying this section,
The relevant sections of 318 follow:
a) General rule. For purposes of those provisions of
this subchapter to which the rules contained in this
section are expressly made applicable--
(1) Members of family.
(A) In general. An individual shall be considered
as owning the stock owned, directly or indirectly,
by or for--
(i) his spouse (other than a spouse who is
legally separated from the individual under a
decree of divorce or separate maintenance),
and
(ii) his children, grandchildren, and
parents.
(B) Effect of adoption. For purposes of
subparagraph (A)(ii), a legally adopted child of
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an individual shall be treated as a child of such
individual by blood.
Subsections (2), (3) and (4) of § 318 provide rules for
attributing ownership to and from partnerships, estates, trusts
and corporations and for dealing with stock options.
Subsection (5) bars double attribution of ownership from
actual owner to family member and then from that family member to
another.
(5) Operating rules.
. . . .
(B) Members of family. Stock constructively owned
by an individual by reason of the application of
paragraph (1) shall not be considered as owned by
him for purposes of again applying paragraph (1)
in order to make another the constructive owner of
such stock.
The plain language of these statutes supports the Tax
Court’s decision that the Garber Industries stock owned by
Kenneth can not be attributed his brother Charles, or vice versa.
Section 382(l)(3)(A) states that “an individual and all members
of his family described in paragraph (1) of section 318(a) shall
be treated as 1 individual for purposes of applying this
section.” The family members listed in paragraph (1) of section
318(a) are a person’s “spouse”, “ his children, grandchildren,
and parents.” This list does not include siblings, which is the
relationship between Charles and Kenneth Garber. Accordingly,
the stock owned by each brother is not treated as owned by the
other and the transaction between them as 5% shareholders
6
triggers an ownership change in the company. We see nothing in
the statute or argument of Garber Industries that persuades us
that this simple reading of section 382 is not the correct one.
Garber Industries puts forward an alternative analysis that
requires some background about the application of § 318. The
parties agree that if the attribution rules of § 318 are applied
to the facts of this case without the modifications in §382, the
stock of each brother would not be considered constructively
owned by the other for two reasons. First, section 318(a)(1)(A)
does not include siblings in the list of family members whose
stock is considered owned by other family members and, second,
because § 318(a)(5)(B) bars double attribution - that is
attribution from child to parent and then from parent to a
sibling as would be required for the Garber brothers’ stock to be
aggregated together. Garber Industries argues that when
§382(1)(3)(A) removed the application of §318(a)(5)(B), double
attribution is allowed. Under this interpretation, the stock of
Kenneth could be attributed to his parent and then to Charles so
that the 1998 sale between them would not cause an ownership
change. We disagree.
We read subsection (l) of § 382 as having two parts that
must be considered together in determining the operating rules
for constructive ownership in the context of NOL carryforwards.
First, the section states that “paragraphs (1) and (5)(B) of
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section 318 (a) shall not apply.” This language has the effect
of removing the attribution rules of § 318 from the stock
ownership analysis. Critically, it removes both subsection (1)1,
which establishes the attribution scheme, and subsection (5)(B)2,
which limits attribution between individuals to one step (no
double attribution). The second clause of § 382(l)(3)(A)(i)
replaces the attribution rules of § 318(a)(1) and (a)(5)(B) with
a different method of grouping ownership among family members,
“an individual and all members of his family described in
paragraph (1) of section 318 (a) shall be treated as 1 individual
for purposes of applying this section.” We believe the flaw in
the taxpayer’s argument is in focusing solely on the removal of §
1
Section 318(a)(1) reads as follows:
(1) Members of family.
(A) In general. An individual shall be considered
as owning the stock owned, directly or indirectly,
by or for--
(i) his spouse (other than a spouse who is
legally separated from the individual under a
decree of divorce or separate maintenance),
and
(ii) his children, grandchildren, and
parents.
2
Section 318(a)(5)(B) reads as follows:
(5) Operating rules.
. . . .
(B) Members of family. Stock constructively owned
by an individual by reason of the application of
paragraph (1) shall not be considered as owned by
him for purposes of again applying paragraph (1)
in order to make another the constructive owner of
such stock.
8
318(a)(5)(B). When we consider the removal of both subsections
(1) and (5)(B) of section 318(a) with the second clause of
section 382(l)(3)(A)(i), we read § 382 as totally replacing the
attribution rules of § 318 with the family grouping model of
§382. Under this interpretation, when determining whether stock
of family members can be aggregated under section 382, the only
question is whether they are members of the same “family” as
described by section 318 - an individual, his spouse, children
and grandchildren. There is nothing in the language of § 382
which suggests that the stock ownership of anyone outside the
limited list of family members in § 318 can be treated as owned
by those within the family group.
Garber Industries also suggests that § 382 can be read to
allow ownership to be attributed to and from a parent without
regard to whether the parent is also a shareholder of the loss
corporation. If this were allowed, a family group could be
formed to aggregate the stock of Kenneth and Charles Garber
around their common parent. We agree with the Tax Court that the
individual or individuals who form the basis for the ownership
analysis must be shareholders of the loss corporation. The whole
point of section 382 is to identify ownership changes relative to
5% shareholders; a change of ownership by such a shareholder is
the only change the statute addresses. 26 U.S.C. § 382(g)(1),
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(g)(2) and (k)(7). An ownership change is defined in terms of
owner shifts affecting 5% shareholders. 26 U.S.C. § 382(g). All
stock owners who are less than 5% shareholders of the corporation
are grouped and their stock is treated as owned by one 5%
shareholder. Id. Accordingly, it follows that the “individual”
referred to in the constructive ownership analysis provisions of
§ 382(l)(3)(A) must be a shareholder and that individual is the
starting point for the formation of a family group consisting of
that individual’s spouse, parents, children and grandchildren.
III.
In summary, the Tax Court properly interpreted § 382 as
applied to a sale of stock between two shareholder brothers, when
no parent or grandparent was a shareholder of the loss
corporation. Section 382, by incorporating the limited family
description from § 318 - spouse, parents, children and
grandchildren - limits the relatives of a shareholder whose stock
can be aggregated with that of shareholder in question and
clearly does not include siblings. The taxpayer’s interpretation
is too broad as it would allow almost unlimited attribution, in
steps, among family members reaching much further than that
limited group. The taxpayer’s attempt to perform the aggregation
analysis through a non-stockholder parent must also fail. The
Tax Court’s use of a shareholder of the loss corporation as the
starting point for stock aggregation is consistent with the
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nature of the analysis under § 382, which looks for ownership
shifts affecting 5% shareholders. Applying these rules to the
facts of this case, the stock of Kenneth and Charles Garber
cannot be aggregated and the 1998 stock sale between them
resulted in an ownership change affecting Garber Industries under
section 382.
For the foregoing reasons, the judgment of the Tax Court is
AFFIRMED.
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