                        T.C. Memo. 2011-189



                      UNITED STATES TAX COURT



                  JESS L. MILLER, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 26567-08.                Filed August 9, 2011.



     Gerald E. Wilson, for petitioner.

     Mindy S. Meigs, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     COHEN, Judge:   Respondent determined a deficiency of

$176,164 in petitioner’s Federal income tax for 2003.    The issue

for decision is whether distributions petitioner received from an

S corporation exceeded his adjusted basis in the corporation’s

stock.   Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year in issue.
                                 - 2 -

                         FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.

Petitioner resided in California at the time he filed his

petition.

     JAM Pharmaceutical, Inc. (JAM), a California corporation,

was organized on July 13, 1995.    On August 29, 1995, petitioner,

through his revocable living trust, acquired all of JAM’s stock--

10,000 shares of common stock.    JAM is a calendar year taxpayer

and made valid S corporation elections for 2002 and 2003.

Petitioner was JAM’s sole corporate officer and director from the

date of organization until 2007, when JAM was dissolved.

     On August 29, 2002, JAM’s articles of incorporation were

amended to authorize the corporation to issue two classes of

stock:   (1) 1 million shares of class A voting common stock, and

(2) 1 million shares of class B nonvoting common stock.

Petitioner, as the sole shareholder and sole corporate officer

and director, consented to the amended articles of incorporation.

Thereafter, petitioner surrendered his 10,000 shares of common

stock for 10,000 shares of class A stock, issued in two

certificates of 5,000 shares, and 90,000 shares of class B stock.

     A purchase agreement dated December 12, 2002, for JAM stock

was executed by petitioner, as seller, and his son, as buyer.

The purchase agreement stated that JAM had 1 million shares of
                               - 3 -

stock and that this represented all of the shares issued and

authorized to be issued.   The agreement also provided that at

closing:   “Seller shall sell to Buyer 950,000 shares of the

Company for a purchase price per share of $.10”.    The closing

date was not identified in the document.   The purchase agreement

also provided that the buyer’s obligation to purchase the shares

from the seller was subject to conditions, including (1) that the

seller would deliver to buyer his resignation as director and

officer of JAM on the closing date and (2) that all of the shares

of JAM would concurrently be sold to buyer.

     On December 31, 2002, petitioner’s adjusted basis in his

100,000 shares of JAM stock was $866,795 (petitioner’s original

basis of $200,000 plus JAM’s accumulated adjustment account

balance of $666,795 as of December 31, 2002).   Petitioner

subsequently transferred 5,000 shares of class A stock and 90,000

shares of class B stock to his son.    Petitioner’s son did not pay

petitioner $95,000 for the JAM stock, and petitioner did not

resign as director and officer of JAM.

     On July 24, 2003, petitioner filed a Form 709, United States

Gift (and Generation-Skipping Transfer) Tax Return, for 2002.     On

the Form 709, petitioner reported transfers of JAM stock on

December 31, 2002, to his son as gifts subject to gift tax as

follows:   (1) 5,000 shares of class A stock with petitioner’s

adjusted basis reported as $43,340 and the value of the gift as
                                  - 4 -

$34,600 and (2) 90,000 shares of class B stock with petitioner’s

adjusted basis reported as $780,116 and the value of the gift as

$511,200.    A business valuation report dated November 5, 2002,

for JAM was attached to the Form 709 that established the fair

market values of the shares of stock as of August 31, 2002,

reported on the return.

     During 2003, JAM made distributions as follows:

               Date          Petitioner    Petitioner’s Son

            Feb. 24           $400,000            ---
            Apr. 11             75,000            ---
            Apr. 14              ---           $170,000
            June 11             53,000          100,000
            Sept. 12            54,000           70,000
            Dec. 30              ---             38,000
            Additional
              distribution      37,551            7,692
              Total            619,551          385,692

     On September 15, 2004, JAM filed a Form 1120S, U.S. Income

Tax Return for an S Corporation, for 2003 and reported ordinary

income of $366,162.    On a Schedule K-1, Shareholder’s Share of

Income, Credits, Deductions, etc., attached to the tax return,

JAM reported that petitioner owned 5 percent of JAM’s stock

during 2003 and that his share of JAM’s ordinary income for 2003

was $18,308.

     On May 9, 2005, the Internal Revenue Service (IRS) received

an amended Form 1120S for 2003 from JAM that reported a loss of

$1,110,390.    The corresponding amended Schedule K-1 for

petitioner reported a loss of $55,519, 5 percent of JAM’s loss.
                               - 5 -

JAM’s reported loss calculation included interest income of

$2,057.

     In 2006, the IRS examined the amended 2003 returns of JAM

and petitioner and determined that JAM had $382,452 of ordinary

income for 2003 and that petitioner’s distributive share was

$19,123.   The IRS examiner determined that in 2003 petitioner

received distributions of $548,664 from JAM that exceeded his

basis in the JAM stock.

     On May 8, 2007, a Form 4605, Examination Changes--

Partnerships, Fiduciaries, Small Business Corporations, and

Interest Charge Domestic International Sales Corporations, was

executed by petitioner’s son as JAM’s majority shareholder

accepting the IRS examiner’s adjustments to JAM’s income,

property distributions other than dividends, section 179 expense

deductions, and charitable contributions, among others.

     On October 9, 2007, petitioner filed a Form 709 reporting

gifts for 2003.   Petitioner did not report a gift of JAM stock in

2003.   Petitioner’s certified public accountant of over 30 years

prepared petitioner’s 2002 and 2003 gift tax returns,

petitioner’s personal income tax return for 2003 (including his

amended return), and the 2003 JAM tax return.

     On August 4, 2008, the IRS sent petitioner a notice of

deficiency for 2003.   The IRS determined that petitioner’s JAM

stock basis was $51,661 after the transfer of 95 percent of his
                                  - 6 -

JAM stock to his son and accordingly $548,664 in distributions

from JAM to petitioner were in excess of his stock basis and

taxable as a long-term capital gain.       In the notice the IRS

adjusted petitioner’s taxable income, resulting in a determined

tax deficiency of $176,164.

                                 OPINION

     The parties agree that the 2003 distributions from JAM to

petitioner totaled $619,551, but they dispute petitioner’s basis

in the JAM stock and accordingly whether distributions he

received from JAM in 2003 exceeded his stock basis.

     Petitioner has the burden of proving the basis of his JAM

stock for purposes of determining the amount of gain he must

recognize.   See sec. 7491(a).    In his brief petitioner asserts

that the burden of proof has shifted to respondent under section

7491(a).   Respondent contends that petitioner’s failure to raise

this argument at or before trial prejudiced respondent’s ability

to present evidence at trial that petitioner did not meet the

requirements of section 7491(a).     We need not address

respondent’s concern because petitioner has not shown that he has

met the requirements of section 7491(a).

     Section 7491(a) requires petitioner to introduce credible

evidence with respect to each issue for which he seeks to shift

the burden of proof.   Petitioner has not satisfied that standard.

See Higbee v. Commissioner, 116 T.C. 438, 442-443 (2001).          He did
                               - 7 -

not identify each issue for which he is seeking to shift the

burden of proof or produce credible evidence relating to the

issue that would shift the burden to respondent.   The testimony

of petitioner was vague and in no way explained away the

consistent reporting that he had a 5-percent interest in JAM in

2003.   Petitioner’s 2002 Form 709 reported that he gave 95

percent of the JAM shares to his son, and a 5-percent interest

for petitioner was reported on JAM’s 2003 Form 1120S and

petitioner’s individual income tax return.   In any event, our

conclusions are based on a preponderance of the evidence, and

thus the allocation of the burden of proof is immaterial.     See

Martin Ice Cream Co. v. Commissioner, 110 T.C. 189, 210 n.16

(1998).

     Section 1366(a)(1) provides that an S corporation

shareholder shall take into account his or her pro rata share of

the S corporation’s items of income, loss, deduction, or credit

for the S corporation’s taxable year ending with or in the

shareholder’s taxable year.   Section 1367 provides that basis in

S corporation stock is increased by income passed through to the

shareholder under section 1366(a)(1), and decreased by, among

other items, distributions not includable in the shareholder’s

income pursuant to section 1368.

     Section 1368(a) provides that a distribution of property

made by an S corporation with respect to its stock to which
                                - 8 -

section 301(c) would apply but for this subsection is treated in

the manner provided in either section 1368(b) or section 1368(c).

A distribution made by an S corporation that has no accumulated

earnings and profits as of the end of its taxable year is treated

in the manner provided in section 1368(b).    See sec. 1.1368-1(c),

Income Tax Regs.    Nothing in the record shows that JAM had

accumulated earnings and profits at the end of 2003; thus section

1368(b) applies to determine the treatment of distributions.

       For S corporations without accumulated earnings and profits,

distributions are not included in a shareholder’s gross income to

the extent that they do not exceed the adjusted basis of the

shareholder’s stock (but are applied to reduce basis), while any

distribution amount in excess of basis is treated as gain from

the sale or exchange of property.    Sec. 1368(b).   For purposes of

section 1368(b), a distribution is taken into account on the date

the corporation makes the distribution, regardless of when the

distribution is treated as received by the shareholder.    Sec.

1.1368-1(b), Income Tax Regs.

       The parties agree that petitioner’s JAM stock basis was

$866,795 before he transferred 95 percent of his shares to his

son.    On his 2002 Form 709, petitioner reported that his adjusted

basis in stock transferred by gift on December 31, 2002, was

$823,456.    Respondent notes that in the notice of deficiency,

petitioner’s adjusted basis in his remaining 5,000 shares after
                                 - 9 -

the transfer of JAM shares to his son was improperly calculated

as $51,661 (instead of $43,339), but respondent does not argue

for application of a figure other than $51,661.

     Petitioner’s 5-percent portion of JAM’s taxable income in

2003 was $19,123 and of JAM’s interest income was $103.    The IRS

used these figures to calculate the determined amount of

petitioner’s JAM stock basis as $70,887 ($51,661 + $19,123 +

$103).   Respondent contends that distributions of $548,664 from

JAM to petitioner were in excess of his basis ($619,551

distributions less $70,887 basis) and should be treated as long-

term capital gain from the sale or exchange of property under

section 1368(b).

     Petitioner first argues that respondent’s determination is

incorrect because he did not give the JAM stock to his son on

December 31, 2002, as was reported on his 2002 Form 709, but

sometime later than that date.    However, he signed the filed Form

709 that reported the gift of 95,000 shares of JAM on that date

and did not file an amended gift tax return.   The stock

certificate stubs identify December 31, 2002, as the date that

95,000 shares of JAM were issued to petitioner’s son.   Petitioner

contends that these stubs were not valid because they were not

executed; however, he testified at trial that he was “not sure”

whether he ever signed a stock assignment.
                                - 10 -

     It is well established that “a transaction is to be given

its tax effect in accord with what actually occurred and not in

accord with what might have occurred” and that “while a taxpayer

is free to organize his affairs as he chooses, nevertheless, once

having done so, he must accept the tax consequences of his

choice, whether contemplated or not”.      Commissioner v. Natl.

Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 148-149 (1974).

     Petitioner did not report a gift of JAM stock in 2003, but

in 2002.   The record, including petitioner’s 2002 Form 709 and

the stock certificate stubs, shows that petitioner gave 95,000

shares of JAM stock to his son on December 31, 2002.      Petitioner

cannot now, after learning of the tax consequences, disavow what

occurred--as reflected in the contemporaneously prepared

documents--with respect to his gift of 95 percent of the JAM

stock to his son.   See Hill v. Commissioner, T.C. Memo. 2010-268.

     Petitioner alternatively argues that he did not actually

give JAM stock to his son, but that there was a part-sale and

part-gift transaction with his son.      He contends on brief that

the purchase price of $95,000 identified in the purchase

agreement should be considered as paid through the additional

distributions that he received from JAM in 2003.

     The record does not show that a sale of the JAM stock,

partial or otherwise, occurred as outlined in the signed

purported purchase agreement.    The purchase agreement terms do
                                - 11 -

not reflect JAM’s August 29, 2002, amended articles of

incorporation authorizing 1 million shares each of class A and of

class B stock.   JAM issued a total of 100,000 shares of stock to

petitioner--not 1 million shares as the purchase agreement terms

indicate.

     Petitioner testified that his son did not pay the purchase

price as identified in the purchase agreement.    Further, the

purchase agreement provided that petitioner would deliver his

resignation as director and officer of JAM to his son on the

closing date (with no closing date identified).    Petitioner did

not do so.   Moreover, petitioner did not report a sale of JAM

stock on his 2002 or 2003 tax return.    Petitioner has not shown

that the JAM stock transfer to his son was a part-sale and part-

gift transaction.

     For a corporation to qualify as an S corporation, it must

have only one class of stock.    Sec. 1361(a), (b)(1)(D).   The

parties do not argue that disproportionate distributions from JAM

created a second class of stock for purposes of section 1361(b).

      Petitioner instead argues that because JAM made

disproportionate distributions and that the distributions did not

create a second class of stock for purposes of section 1361(b)

upon examination, that the disproportionate distributions should

be “recharacterized”.   Petitioner contends that the

disproportionate distributions during 2003 varied because JAM’s
                              - 12 -

shareholders changed during that year and that accordingly the

effective date of the transfers of JAM stock from petitioner to

his son should be treated as occurring after the disproportionate

distributions.

     Section 1.1361-1(l)(2)(i), Income Tax Regs., provides, in

part:

     Although a corporation is not treated as having more
     than one class of stock so long as the governing
     provisions provide for identical distribution and
     liquidation rights, any distributions (including
     actual, constructive, or deemed distributions) that
     differ in timing or amount are to be given appropriate
     tax effect in accordance with the facts and
     circumstances.

     Petitioner contends that because the parties agree that JAM

was an S corporation in 2002 and 2003, it cannot be argued that

the one-class-of-stock rules have been violated and thus the

disproportionate distributions in 2003 should be given

appropriate tax effect in accordance with the facts and

circumstances.   See sec. 1.1361-1(l)(2)(i), Income Tax Regs.

Petitioner does not directly argue that the character of the

disproportionate distributions should change to give them proper

tax effect, but asserts that recharacterization should apply to

treat the effective date of the transfers of JAM stock from

petitioner to his son as occurring after the disproportionate

distributions.

     Petitioner relies on an example in the regulations under

section 1361 that addresses whether an S corporation with
                                - 13 -

distributions that differ in timing should be treated as having

more than one class of stock.    See sec. 1.1361-1(l)(2)(vi),

Example (2), Income Tax Regs.    In the example, an S

corporation with two equal shareholders entitled to equal

distributions under the S corporation’s bylaws distributes an

amount to one shareholder in the current year and an equal amount

to the other shareholder the following year, with circumstances

that indicate the difference in timing did not occur because of a

binding agreement relating to distribution or liquidation

proceeds.   Id.   The example explains that the difference in

timing of the distributions to the shareholders does not cause

the S corporation to be treated as having more than one class of

stock.   Id.

     Petitioner has not offered evidence to show whether JAM made

corrective distributions, nor has he asserted that the

“character” of the distributions should change to give them

appropriate tax effect.   He instead contends that the effective

date of the transfer of stock should be recognized as occurring

after the disproportionate distributions, implying somewhat

obscurely that the logic of the example he cites supports his

position.   The example terms do not address an effective date

“recharacterization” when disproportionate distributions are made

to a valid S corporation with one class of stock, but explain

that distributions that are different in timing may be equalized
                                - 14 -

within a period of time to avoid violating the one-class-of-stock

provision.    See id.   Petitioner’s argument for recharacterization

is not supported by the facts and circumstances.

     We conclude that on December 31, 2002, petitioner made a

gift of 95,000 shares of JAM stock to his son, leaving petitioner

with a 5-percent interest in JAM with an adjusted basis of

$51,661.     Accordingly, in 2003 petitioner received distributions

from JAM in excess of his JAM stock basis, resulting in a long-

term capital gain to petitioner.    All arguments of the parties

have been considered; to the extent not addressed they are

without merit or moot.    For the reasons stated herein,


                                           Decision will be entered

                                      for respondent.
