                  T.C. Memo. 2005-274



                UNITED STATES TAX COURT



            GLENN HIGHTOWER, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 8679-04.              Filed November 28, 2005.



     Petitioner (P) and Daniel O’Dowd each owned 50
percent of the stock of an S corporation (GH). O’Dowd
exercised his rights under the shareholders’ agreement
to buy P’s shares. P opposed the buyout in arbitration
proceedings to which P and O’Dowd had agreed to be
bound. In 2000, the arbitrator ruled against P, and P
received $41,585,388 in exchange for his GH stock. P
deposited the payment in an interest-bearing account.
From 2000 to 2003, P unsuccessfully opposed the buyout
in California State courts.

     P received no dividends from GH in 2000, but he
retained the right to receive dividends and vote his
shares of GH stock.

     Held: P is taxable on the payment he received for
his GH stock and related interest in the years paid.

     Held, further, P is taxable on a distributive share
of GH’s income in 2000.
                                - 2 -

     Glenn Hightower, pro se.

     Catherine Campbell, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     COLVIN, Judge:    Respondent determined deficiencies in

petitioner’s Federal individual income tax of $7,535,620 for 2000

and $389,455 for 2001.   After respondent’s concession,1 the

issues for decision are:

     1.   Whether $41,585,388 petitioner received in 2000 in a

corporate stock buyout of his shares in an S corporation and

interest credited in 2000 and 2001 to the account in which he

deposited the payment is included in petitioner’s income for

those years.   We hold that it is.

     2.   Whether petitioner is required to include in income for

taxable year 2000 a distributive share of the S corporation’s

2000 income.   We hold that he is.

     Unless otherwise indicated, section references are to the

Internal Revenue Code as amended in effect for the years in

issue, and Rule references are to the Tax Court Rules of Practice

and Procedure.




     1
        Respondent concedes that the amount of petitioner’s
unreported interest income for 2001 is $44,021 less than
respondent determined in the notice of deficiency.
                                - 3 -

                          FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

Petitioner resided in Issaquah, Washington, when the petition in

this case was filed.

A.   Green Hills Software, Inc.

     1.   Formation

     Daniel O’Dowd (O’Dowd), petitioner, and a third individual

organized Green Hills Software, Inc. (Green Hills), as a

California corporation in 1986.    Green Hills became a Delaware

corporation in 1986.    Green Hills was an S corporation for

Federal income tax purposes at all relevant times.

     Petitioner and O’Dowd bought the stock of the third

individual in 1992.    They each owned 30,000,300 shares

thereafter.   Petitioner was chairman of the board and secretary,

and O’Dowd was president and treasurer.      Petitioner and O’Dowd

were Green Hills’ only directors.

     2.   Buyout Provisions in the Shareholders’ Agreement

     Petitioner and O’Dowd entered into a shareholders’ agreement

in 1992 which provided that any dispute between them would be

resolved through binding arbitration.    It also provided that

either of them could compel a buyout of the stock held by the

other at a price determined by a formula.
                                - 4 -

     3.     Events Leading to O’Dowd’s Buyout of Petitioner’s Stock

     Relations between O’Dowd and petitioner deteriorated in 1997

and 1998.    Petitioner went to Green Hills’ headquarters on March

15, 1998.    O’Dowd demanded that petitioner leave and threatened

to call the police if petitioner refused.    On March 25, 1998,

O’Dowd notified petitioner that his access to the company was

denied, that the locks had been changed, and that his employment

and access to the computer system had been terminated.

     Petitioner was the record owner of his shares until October

13, 2000.    He retained the right to vote his stock and to receive

dividends until that date.    He received dividends in 1998 and

1999, no dividends in 2000, and a salary of $13,822 in 1998,

$51,381 in 1999, and $16,666 in 2000.

     4.     O’Dowd’s Buyout of Petitioner

     In a letter dated June 26, 1998, O’Dowd properly triggered

the buy/sell provision of the shareholders’ agreement by offering

either to sell his shares to petitioner for $47 million or to buy

petitioner’s shares for $47 million.    The letter also stated that

O’Dowd had deposited with Green Hills a certified check for $47

million payable to petitioner in conformity with the

shareholders’ agreement.    Petitioner did not want to sell his

stock.    Instead, he wanted to exercise his right under the

shareholder’s agreement to buy O’Dowd’s stock for the amount

O’Dowd had offered for petitioner’s stock ($47 million).
                                  - 5 -

However, petitioner could not obtain financing.     Thus, O’Dowd

compelled a buyout of petitioner’s stock.

B.   Arbitration

     1.      Proposed Interim Award

     On August 24, 1998, pursuant to the arbitration clause of

the shareholders’ agreement, petitioner demanded arbitration

regarding O’Dowd’s buyout.     On December 1, 1999, the arbitrator

issued a proposed interim award (the December 1999 award) finding

that O’Dowd had not acted improperly in his attempt to buy

petitioner’s shares.    The December 1999 award stated that the

arbitrator would reassess the award after considering motions for

reconsideration and entry of partial final award.

     2.     Partial Final Award

     The arbitrator issued a partial final award on March 8,

2000.     The arbitrator found that O’Dowd’s actions were consistent

with the buyout provision of the shareholders’ agreement.     The

award permitted O’Dowd to treat the purchase of petitioner’s

stock as having occurred on September 24, 1998, 90 days after

O’Dowd invoked the buyout provision of the shareholders’

agreement.     The arbitrator made the following findings:   (a) But

for petitioner’s failure to tender his shares to O’Dowd within 90

days of O’Dowd’s deposit of $47 million with Green Hills, his

legal or beneficial interest in Green Hills would have terminated

on September 24, 1998; (b) O’Dowd has the right but not the
                                 - 6 -

obligation to pay or cause Green Hills to pay petitioner for the

shares ($47 million) by September 24, 1998; (c) the purchase

price shall be reduced by dividends and salary (net after payment

of taxes) paid to petitioner for the period after September 24,

1998; and (d) until O’Dowd completes the purchase of petitioner’s

stock, petitioner shall be paid all dividends in accordance with

the shareholders’ agreement, which payments shall offset the

purchase price for the shares.

     3.   Corrected Partial Final Award

     The arbitrator issued a corrected partial final award on

April 25, 2000, which provides in pertinent part:

     The purchase price shall be offset and reduced by all
     dividends paid to * * * [petitioner] based on Green
     Hills’ earnings for the Third Quarter of 1998 and
     thereafter until the date of purchase of * * *
     [petitioner’s] share; said offset shall be reduced by
     the amount of ordinary taxable income of Green Hills
     (excluding long term capital gains) attributable to
     * * * [petitioner] for the period September 24, 1998
     until the purchase date multiplied by a fraction the
     numerator of which is .1367 and the denominator of
     which is .7070.

     Petitioner filed a petition in the California Superior Court

for the County of Los Angeles (the Superior Court) and a petition

for writ of mandate in the Court of Appeal of the State of

California for the Second District (the Court of Appeal) in an

effort to have the partial final award vacated.   Both petitions

were denied.
                               - 7 -

C.   Payment to Petitioner for His Green Hills Stock

     1.   Adjusted Purchase Price

     Green Hills hired an accountant to compute the adjusted

purchase price pursuant to the corrected partial final award.2

The accountant estimated the adjusted total purchase price for

petitioner’s shares to be $42,862,230.95 as of October 15, 2000.

     2.   Delivery and Deposit of Payment

     On October 13, 2000, O’Dowd delivered checks to petitioner

in the amounts of $32,585,388 and $9 million as payment for

petitioner’s shares in Green Hills.    Both checks were dated

October 13, 2000.   The face and endorsement areas of each check

indicated that the check was not valid if presented for payment

after October 23, 2000.   O’Dowd drafted a receipt for the checks

that read in pertinent part: “Receipt of * * * [checks]

aggregating $41,585,388 as payment for all of the shares of Glenn

Hightower in Green Hills Software, Inc. is hereby acknowledged.”

Petitioner crossed out the phrase “as payment for all of the

shares of Glenn Hightower in Green Hills Software, Inc.”, signed

the receipt, and deposited the checks in an interest-bearing bank


     2
        The accountant computed the adjustment by, among other
things, subtracting $3,163,484 of dividends paid in 1998 and 1999
and adding .1367/.7070 of $6,251,054 total ordinary taxable
income for 1998 and 1999, and .1367/.7070 of $3,494,666 estimated
ordinary taxable income for 2000 through Oct. 15, 2000. The
payment to petitioner was increased by approximately the amount
of petitioner’s Federal income tax on a distributive share of
income from Green Hills. See par. B. in Opinion, below.
                               - 8 -

account that petitioner had opened in his own name solely to hold

the funds.

     In a letter to O’Dowd dated October 13, 2000, petitioner’s

attorney stated:   (a) Petitioner would tender his shares of Green

Hills to O’Dowd, as required by the arbitrator’s award under

protest, and without waiver of any rights or remedies; (b) the

shares were to be held in trust; and (c) petitioner was not

entitled to the checks.   Petitioner delivered his stock to O’Dowd

on October 13, 2000.   Petitioner did not endorse the shares.

     Interest was credited to petitioner’s account in the amounts

of $469,593.63 in 2000 and $1,513,788.28 in 2001.   There were no

transactions on the account in 2000 or 2001 other than the

crediting of interest and withholding of Federal income tax.

     In a letter to petitioner’s attorney dated November 21,

2000, O’Dowd’s attorney stated that the account into which

petitioner had deposited the $41,585,388 was not a trust account.

O’Dowd’s attorney offered to hold the funds for petitioner in the

attorney’s trust account.   Petitioner did not respond to the

offer.

D.   Later Events Relating to the Arbitration

     In February 2001, the Court of Appeal denied petitioner’s

request to stay the arbitration proceedings.    Petitioner filed a

motion for rehearing with the Court of Appeal, and the motion was

denied.   Petitioner filed a petition for review in the Supreme
                                - 9 -

Court of California on March 28, 2001.   The petition was denied

on May 16, 2001.

     The arbitrator issued a final award in the arbitration

proceedings on August 29, 2001.   He found that:   (1) O’Dowd’s

purchase of petitioner’s Green Hills stock for $41,585,388

complied with the partial final award and was effective on

October 13, 2000; (2) the payment belongs to petitioner without

restriction; (3) petitioner’s acceptance of the payment on

October 13, 2000, terminated his interest in Green Hills; (4)

petitioner is entitled to an additional $52,783;3 (5) O’Dowd is

entitled to $604,105.30 for attorney’s fees, costs, and expenses;

and (6) the net amount petitioner owes O’Dowd is $551,322.30.

     On December 11, 2001, petitioner petitioned the Superior

Court to vacate the arbitration award.    On December 21, 2001, the

Superior Court entered a judgment confirming and substantially

repeating the findings in the arbitrator’s final award.

     Petitioner appealed the Superior Court’s decision.    On July

31, 2003, the Court of Appeal filed its opinion rejecting

petitioner’s appeal and affirming the decision of the Superior

Court.    Petitioner filed a motion for rehearing on August 15,

2003.    Petitioner’s motion was denied on August 20, 2003.

Petitioner filed a petition for review in the Supreme Court of


     3
        This adjustment was made to correct an error in the
calculation of the offsets to the purchase price.
                               - 10 -

California on September 9, 2003.    That petition was denied on

October 22, 2003.    No other actions concerning the validity of

the buyout were pending on the date of trial.

E.   Petitioner’s Basis in Green Hills Stock, Distributive Share
     of Income From Green Hills, and Income Tax Returns for 2000
     and 2001

     Petitioner’s basis in Green Hills stock was $8,315,584 on

December 31, 1999.    Green Hills reported $4,275,909 as

petitioner’s distributive share of income through October 13,

2000.4

     Petitioner filed Federal income tax returns for 2000 and

2001 on the cash receipts and disbursements method of accounting.

On his 2000 return, petitioner did not include a distributive

share of income from Green Hills.    Petitioner did not include in

income on his 2000 and 2001 returns the $41,585,388 payment or

any of the interest credited to the account in which he had

deposited that payment.




     4
        In the notice of deficiency, respondent determined that
petitioner’s basis in Green Hills was $12,523,085 for purposes of
determining petitioner’s gain on the sale of Green Hills stock on
Oct. 13, 2000. Adding a $4,275,909 distributive share of income
to petitioner’s basis in Green Hills of $8,315,584 on Dec. 31,
1999, does not produce the basis determined by respondent. The
record does not show whether respondent determined petitioner’s
basis correctly. Thus, if we decide that the $41,585,388 is
includable in petitioner’s income in the year received, the
parties shall compute the amount of gain under Rule 155.
                               - 11 -

                              OPINION

A.   Whether the Payments at Issue Are Taxable to Petitioner in
     the Years Received

     1.   Contentions of the Parties

     The parties dispute whether the payment to petitioner for

the stock buyout and related interest are taxable to petitioner

in 2000 and 2001.   Petitioner contends that those amounts are not

taxable in those years because of the claim of right doctrine.

Respondent disagrees.5   We agree with respondent.

     Income includes all economic gains not specifically exempted

from taxation.   See sec. 61; Commissioner v. Glenshaw Glass Co.,

348 U.S. 426, 429 (1955).    Income is generally taxable in the

year in which the taxpayer receives it unless, under the method

of accounting used by the taxpayer, the amount is properly

taxable in another year.    Sec. 451(a).   For taxpayers using the

cash method of accounting, income is taxable in the year actually

or constructively received.    Sec. 1.451-1(a), Income Tax Regs.

     Under the claim of right doctrine, a payment is includable

in income in the year in which a taxpayer receives it under a

claim of right (even if that claim is disputed by another party)



     5
        Income generally includes proceeds of a stock sale (less
a taxpayer’s basis) and interest on money received. Secs.
61(a)(3), (4), 1001. Respondent contends that petitioner
received income in the amount of the gross proceeds less his
basis in the stock, plus all of the interest credited to the
account in which he had deposited that payment.
                              - 12 -

and without restriction as to its disposition.6   Healy v.

Commissioner, 345 U.S. 278, 281-282 (1953); United States v.

Lewis, 340 U.S. 590, 591 (1951); N. Am. Oil Consol. v. Burnet,

286 U.S. 417 (1932).7   The claim of right doctrine results in

part from the requirement to account for income annually.     Healy

v. Commissioner, supra at 281; United States v. Lewis, supra at

592; Burnet v. Sanford & Brooks Co., 282 U.S. 359, 363 (1931).

     The burden of proving a factual issue relating to liability

for tax shifts to the Commissioner under certain circumstances.

Sec. 7491(a).   Petitioner does not contend that section 7491

applies.   Thus, petitioner bears the burden of proof.   See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

     2.    Whether the Payments at Issue Are Taxable in the Years
           Received

     We next consider petitioner’s argument that, under the claim

of right doctrine, petitioner is excused from the general rule

that income is taxable in the year in which the taxpayer receives


     6
        See generally Lister, “The Use and Abuse of Pragmatism:
The Judicial Doctrine of Claim of Right”, 21 Tax L. Rev. 263
(1966).
     7
        In N. Am. Oil Consol. v. Burnet, 286 U.S. 417, 424
(1932), the Supreme Court articulated the claim of right doctrine
as follows:

     If a taxpayer receives earnings under a claim of right
     and without restriction as to its disposition, he has
     received income which he is required to return, even
     though it may still be claimed that he is not entitled
     to retain the money, and even though he may still be
     adjudged liable to restore its equivalent.
                               - 13 -

it.   Petitioner contends that the general rule does not apply

because the conditions for application of the claim of right

doctrine (i.e., receipt of income under a claim of right and

without restriction as to its disposition) have not been met.

            a.   Whether Petitioner Received Income in 2000 and
                 2001

      Petitioner argues that he did not receive a payment from

O’Dowd in 2000 because he held O’Dowd’s payment in trust in a

segregated account.    We disagree.   Petitioner received the funds

and deposited them in an account he had opened in his name.

There is no evidence that petitioner held the funds in trust.

      Petitioner argues that the funds were not income until the

litigation was final and that the sale was incomplete because he

tendered his shares without endorsing the certificates.    We

disagree.    The arbitrator found in the partial final award in

2000, which the California courts later affirmed, that

petitioner’s stock was purchased in 2000.    We conclude that

petitioner received payment for his stock in 2000 when he

received the checks and that he received interest thereon in 2000

and 2001 when it was credited to the bank account into which he

had deposited the payment.    This result is not changed by the

fact that petitioner did not endorse the stock certificates.
                                - 14 -

          b.      Whether Petitioner’s Disposition of the Funds Was
                  Restricted

     Petitioner deposited the stock payment in an interest-

bearing account which he established solely to hold those funds.

He did not withdraw or otherwise use the payment or interest

credited to that account during the years at issue.    However,

absence of use of funds by a taxpayer does not prevent inclusion

of the funds in income under the claim of right doctrine.    See

Commissioner v. Alamitos Land Co., 112 F.2d 648, 650-651 (9th

Cir. 1940), revg. 40 B.T.A. 353 (1939) (funds received in

litigation were income in year paid even though the funds were

shown on the taxpayer’s books as a reserve to be repaid to an

adverse litigant if successful on appeal).

     Petitioner argues that his use of the funds was restricted

by State law in that if he accepted the funds, Green Hills would

have negative retained earnings which is prohibited by California

and Delaware law.8    Even if payment of the funds to petitioner

violated State law, a subsequent determination to that effect

would not absolve petitioner from his tax liability in the year

of the receipt.    See Healy v. Commissioner, supra; Wentworth v.

Commissioner, 510 F.2d 883, 886 (6th Cir. 1975), affg. T.C. Memo.

1973-199; Hamlett v. Commissioner, T.C. Memo. 2004-78.




     8
        The parties do not contend that the result on this issue
differs depending whether California or Delaware law applies.
                             - 15 -

          c.   Whether Petitioner’s Opposition to the Buyout
               Precludes Taxation of the Payments in the Years
               the Payments Were Received

     Petitioner contends that under the claim of right doctrine

the payments are not taxable to him in the years he received them

because he opposed the stock buyout, he established a separate,

interest-bearing account to hold the payments, and he did not use

the funds during the years in issue.

     Contrary to petitioner’s contention, a payment properly made

to a taxpayer is includable in income in the year paid if, as

here, the taxpayer (a) receives and deposits the payment in an

unrestricted account, (b) seeks to invalidate the transaction or

circumstance which caused the payment to be made, and (c) has no

fixed obligation to pay the amount to another party.     Hope v.

Commissioner, 471 F.2d 738, 741-742 (3d Cir. 1973) (sale of stock

taxable in year of sale despite taxpayers’ efforts to rescind

stock sale in that year), affg. 55 T.C. 1020 (1971).   In

addition, a taxpayer is taxable in the year the taxpayer receives

wages where the taxpayer tried to return the wages to her

employer and the employer refused to accept repayment.      Miller v.

Commissioner, T.C. Memo. 1963-341, affd. without published

opinion 15 AFTR 2d 321, 65 USTC par. 9,288 (9th Cir. 1965).     In

both of these cases, like the instant case, the taxpayer’s

renunciation was not accepted by the other party.
                              - 16 -

     A payment may not be taxable in the year it is received if,

in that year, the recipient-taxpayer recognizes an unconditional

obligation to pay it to another party.    See Bates Motor Transp.

Lines, Inc. v. Commissioner, 200 F.2d 20, 24 (7th Cir. 1952),

affg. 17 T.C. 151 (1951).   As another example, amounts paid by a

customer to a taxpayer were not income in the year received to

the extent that the taxpayer acknowledged an obligation to pay

the amounts to the taxpayer’s supplier, even though the agreement

was unenforceable.   Lashells’ Estate v. Commissioner, 208 F.2d

430, 435 (6th Cir. 1953), affg. in part, revg. in part and

remanding a Memorandum Opinion of this Court; Shaara v.

Commissioner, T.C. Memo. 1980-247.

     Petitioner asserts that Hope v. Commissioner, supra, is

distinguishable because in Hope the taxpayers instituted the

stock sale and then tried to rescind it, while petitioner opposed

the transaction from the beginning.    We disagree that this

factual distinction is significant.    What we believe is

controlling is that, like the taxpayers in Hope v. Commissioner,

supra, and Miller v. Commissioner, supra, petitioner’s

renunciation of the right to the amount received was not coupled

with an unconditional agreement or understanding with another

party to return the amount received.
                                - 17 -

     Petitioner relies on United States v. Merrill, 211 F.2d 297,

302-303 (9th Cir. 1954).9    In that case, the Court of Appeals for

the Ninth Circuit held that a payment mistakenly made to a

taxpayer who had no right to receive it is not taxable in the

year of receipt if, in that year, the taxpayer renounces any

claim to the funds, recognizes an obligation to repay, and makes

provision for repayment in the form of a journal entry on the

taxpayer’s books.     Id. at 303-304.    Petitioner’s situation

differs from that of the taxpayer in Merrill because the payment

of funds to petitioner was not a mistake, petitioner had the

right to receive the funds, and there was no existing agreement

with O’Dowd to return the payment.       In Bates Motor Transp. Lines,

Lashells’ Estate, and Merrill, each recipient of funds had an

agreement with another party during the year of receipt to return

the funds.

     Petitioner contends that he involuntarily received the

funds, that he unconditionally renounced his right to them, and

that he thought that not cashing the checks may have caused him

to lose the $41,585,388 or be subject to the cost of financing an

additional purchase.    We disagree.     He voluntarily cashed the

checks he received.    Creating a separate account to hold the


     9
        We relied on the holding in United States v. Merrill,
211 F.2d 297, 302-303 (9th Cir. 1954), in Bishop v. Commissioner,
25 T.C. 969, 974 (1956). See also Gaddy v. Commissioner, 38 T.C.
943, 947-948 (1962), affd. in part and remanded in part on
another issue 344 F.2d 460 (5th Cir. 1965).
                              - 18 -

funds does not show that petitioner unconditionally renounced his

right to the funds.   Petitioner’s renunciation was not pursuant

to an “existing” or “fixed” agreement to return the funds.   On

the contrary, petitioner intended to return the funds only if he

succeeded in rescinding O’Dowd’s buyout.10

          d.   Conclusion

     As stated above, income is generally taxable in the year in

which the taxpayer receives it unless, under the method of

accounting used by the taxpayer, the amount is properly taxable

in another year.   Sec. 451(a).   Under the claim of right

doctrine, this principle applies to income received by a taxpayer

and over which the taxpayer has unrestricted use, even if the

taxpayer’s claim to the income is disputed by another party.

Petitioner accepted and kept the payment and related interest


     10
        Neither party cited Sohio Corp. v. Commissioner, 163
F.2d 590 (D.C. Cir. 1947), revg. 7 T.C. 435 (1946). In that
case, the Court of Appeals for the District of Columbia held that
a taxpayer which (1) was required by Illinois law to receive
income, (2) would have been subject to monetary penalties if it
had not received the income, (3) protested the payment, and (4)
immediately commenced and later prevailed in a court challenge to
the constitutionality of the statute under which the payment was
received did not have income in the year of receipt. Id. at 593.

     Petitioner’s situation is distinguishable from that of the
taxpayer in Sohio Corp. v. Commissioner, supra. The taxpayer in
Sohio Corp. did not receive and retain the payment voluntarily,
but rather did so under the compulsion of State law and the
threat of heavy penalties. Id. at 593. In contrast, petitioner
agreed to be bound by the shareholders’ agreement that contained
the buyout provision and arbitration procedures. The receipt,
retention, and deposit of funds in petitioner’s bank account were
voluntary.
                               - 19 -

until he learned if his appeal would be successful.   Under these

circumstances, we hold that the payment and related interest are

taxable in the years petitioner received them.

B.   Whether Petitioner Must Include in His Income a Distributive
     Share of Green Hills’ Income

     The next issue for decision is whether petitioner must

include in his income for 2000 a distributive share of Green

Hills’ income from January 1 to October 13, 2000.

     1.    Taxation of S Corporation Income

     Generally, income, losses, deductions, and credits of an S

corporation are passed through pro rata to shareholders on their

individual income tax returns based on days of ownership whether

or not the income is distributed.   Secs. 1363(a), 1366(a),

1366(c), 1377(a)(1).   Ordinarily, the person who would be taxable

on a dividend if the corporation were a C corporation is

considered to be the shareholder of an S corporation.   Sec.

1.1361-1, Income Tax Regs.11




     11
          Sec. 1.1361-1, Income Tax Regs., provides in part:

          (e) Number of Shareholders.   (1) * * *
     Ordinarily, the person who would have to include in
     gross income dividends distributed with respect to the
     stock of the corporation (if the corporation were a C
     corporation) is considered to be the shareholder of the
     corporation. * * * The person for whom stock of a
     corporation is held by a nominee, guardian, custodian,
     or an agent is considered to be the shareholder of the
     corporation for purposes of this paragraph (e) and
     paragraphs (f) and (g) of this section. * * *
                                - 20 -

     2.     Petitioner’s Contentions

     When the record owner of S corporation stock holds that

stock for the benefit of another, such as a nominee, agent, or

passthrough entity, income, losses, deductions, and credits of

the corporation are passed through not to the record owner but to

the beneficial owner of the stock.       Sec. 1.1361-1(e), Income Tax

Regs.     A taxpayer is the beneficial owner of property if the

taxpayer controls the property or has the economic benefit of

ownership of the property.     Anderson v. Commissioner, 164 F.2d

870 (7th Cir. 1947), affg. 5 T.C. 443 (1945).

     Petitioner contends, in effect, that he was not the

beneficial owner of his Green Hills stock in 2000, and no Green

Hills income passes through to him, because beginning before 2000

O’Dowd improperly excluded him from the benefits of ownership of

that stock.     We disagree.

     First, petitioner has cited no authority for the proposition

that a record owner of S corporation stock is not subject to pass

through of S corporation income because the record owner has a

diminished role in the corporation as a result of having a poor

relationship with another shareholder.      Courts have frequently

considered whether an individual is a beneficial owner of the

stock of an S corporation in deciding whether that person will be

treated as a shareholder of that corporation for tax purposes.

See, e.g., Pahl v. Commissioner, 150 F.3d 1124 (9th Cir. 1998),
                             - 21 -

affg. T.C. Memo. 1996-176; Cabintaxi Corp. v. Commissioner, 63

F.3d 614 (7th Cir. 1995), affg. in part and revg. in part T.C.

Memo. 1994-316; Wilson v. Commissioner, 560 F.2d 687 (5th Cir.

1977), affg. T.C. Memo. 1975-92; Anderson v. Commissioner, supra;

Yelencsics v. Commissioner, 74 T.C. 1513 (1980); Hook v.

Commissioner, 58 T.C. 267 (1972); Beirne v. Commissioner, 52 T.C.

210 (1969); Hoffman v. Commissioner, 47 T.C. 218 (1966), affd.

per curiam 391 F.2d 930 (5th Cir. 1968).   All of these situations

involve an arrangement between parties who had some agreement or

understanding regarding their relationship with each other.12

However, in none of these cases was the profit of an S

corporation not passed through to one of its shareholders because

of a poor relationship between the shareholders.   We conclude

that the beneficial ownership test does not relieve petitioner

from passthrough of Green Hills profits.

     Second, respondent alleges, and petitioner does not deny,

that the payment to petitioner for his Green Hills stock was

increased by approximately the amount of petitioner’s Federal

income tax on a 50-percent distributive share of income from




     12
       See generally Bravenec, Federal Taxation of S
Corporations and Shareholders, pp. 7-12 to 7-13 (2d ed. 1988),
showing examples of when beneficial ownership test is applied:
creditor vs. debtor; nominal shareholder vs. creditor; donor vs.
donee; estate vs. heir; entity vs. shareholder; buyer vs. seller;
subscriber, redeeming shareholder, or director vs. corporation.
                               - 22 -

Green Hills.13   Petitioner received through the arbitrator’s

award a payment compensating him for his increased Federal income

tax liability.   Petitioner would receive a windfall if he were

not required to pay the tax which was already paid to him as part

of the sale of his Green Hills stock.   Petitioner makes no

persuasive argument that removes this situation from the general

definition of a shareholder under section 1.1361-1, Income Tax

Regs.




     13
        The purchase price was increased by the distributive
share of taxable income multiplied by a fraction the numerator of
which is .1367 and the denominator of which is .7070. The
.1367/.7070 fraction is about 0.1933. Thus, the purchase price
was increased by about 19.33 percent of the total distributive
share of income. The top marginal rate of tax on ordinary income
for unmarried individuals for 1998, 1999, and 2000, was 39.6
percent. Sec. 1(c). However, the top marginal rate on capital
gains income for 1998 was 20 percent, see sec. 1(h)(1)(C), or 18
percent for qualified 5-year gain, see sec. 1(h)(2)(B).
Petitioner incurred tax on his distributive share of income at
the ordinary income rates, and increased his basis in his Green
Hills stock by the same amount. If he had sold his stock in
1998, he would not have incurred tax on his distributive share of
income in 1998, 1999, and 2000, but his capital gain would have
been higher by the amount of this distributive share of income.
Even though petitioner’s taxable income would be the same, he
incurred more tax than he would have because the capital gains
rates are lower than the ordinary income rates. Respondent
asserts (and petitioner does not deny) that the arbitrator used a
formula to increase the purchase price to compensate petitioner
for the difference between Federal income tax imposed on a
distributive share of income (for which he would not have been
held liable if he had sold the stock on Sept. 24, 1998, but which
the parties recognized petitioner was liable or for which he was
going to be liable) and that imposed on the change in his capital
gain (which would have been higher had the stock been sold in
1998 and petitioner not incurred an additional distributive share
of income).
                             - 23 -

     3.   Conclusion

     We conclude that petitioner must include in income a 50-

percent share of the income Green Hills earned in 2000 until

October 13, 2000.

     To reflect the foregoing and respondent’s concession,



                                             Decision will be

                                        entered under Rule 155.
