When the Internal Revenue Service publishes a revenue ruling, taxpayers whose situations are covered by the ruling ought to be able to rely on the mandate in planning and executing transactions. Right?
Likewise, the government should not be able to disavow the ruling (if it has not been previously revoked) in the context of a judicial proceeding challenging the transaction. The case titled Raeunhorst v. Commissioner teaches this important lesson.
In the case, the taxpayer owned warrants in a closely held corporation. On September 28, 1993, a prospective suitor submitted to the corporation’s management a letter of intent, which was accepted. Matters progressed, and on October 22, 1993, the acquirer’s board of directors adopted a resolution to enter into an agreement for the purchase of the corporation’s entire outstanding stock.
Later, on November 9, 1993, the taxpayer executed, on behalf of certain charities, an “assignment” of warrants. The donees acknowledged having received “reissued” warrants on November 12, 1993. Next, on November 22, 1993, the acquirer and the corporation executed an agreement for purchase of the corporation’s entire outstanding stock, and finally on December 22, 1993, the transaction closed.
Staffers at the IRS argued that the donation of the warrants was an “assignment of income,” and hence, the proceeds from the sale of the warrants should properly be taxed to the taxpayer—the donor of the warrants. The IRS officials argued that there were two alternative tests that apply in determining whether a donation of property (in connection with the sale of the property) should be treated as an assignment of income:
- In the case of a “global” transaction—in which all the stock of a corporation is to be acquired—the proper test is whether at the time of the donation, the sale of the donated property has “ripened to a practical certainty.” This test, which examines all of the facts and circumstances of the transaction, is based on the “realities and substance” of what transpired.
- Conversely, in the case of a “non-global” transaction—in which less than all of the stock of a corporation is to be acquired—the appropriate test for ascertaining whether an assignment of income has occurred is a more objective test. The test is found in Rev. Rul. 78-197, the IRS’s acquiescence to the well-known Palmer decision.
According to this ruling, an assignment of income has only occurred if the donee, at the time of the gift, is either legally bound or can be compelled by the corporation to surrender the donated shares.
However, the U.S. Tax Court disagreed with the proposition that two alternative tests exist for ascertaining whether an assignment of income has taken place. The case law, according to Tax Court rulings, applies the very same assignment of income principles to global transactions as they apply to non-global ones. Instead, the IRS’s attempt to establish the presence of multiple assignment of income tests was simply an attempt to disavow its own published guidance on this topic—the guidance found in Rev. Rul. 78-197.
The court was not, in the interest of sound and uniform administration of the tax laws and of simple fairness, prepared to allow the IRS to argue against its own “public guidance” as articulated in Rev. Rul. 78-197. If the IRS is unhappy with the ruling, it needs to revoke it. In short, the court regarded the continued existence of the revenue ruling as nothing less than a “concession” on the part of the IRS, with respect to the application of the assignment of income rule.
Accordingly, the court, which has never felt totally comfortable with the “bright line” test that Rev. Rul. 78-197 espouses—and has declined to wholeheartedly embrace the test when it is free to do so—limited its inquiry to the question of whether the taxpayer’s donees were legally obligated, or under a compulsion, to sell such warrants at the time of the gifts of the warrants. Clearly, they were not.
As a result, the transaction was taxed in accordance with its form. The taxpayer was not charged with any income, notwithstanding the preplanned, although not compelled, sale of the warrants some 40 days after they were conveyed to the new owners.