Contested Buyout Doesn't Bar Gain

Article excerpt

The Ninth Circuit Court of Appeals affirmed the Tax Court's decision that a cash-method shareholder's forced buyout triggers gain recognition in the year that the buyout payment is received, even if the shareholder continues to dispute the buyout in court. Additionally, the shareholder must recognize any interest income from investment of the buyout funds as taxable in the year it is received.

Glenn Hightower and Daniel O'Dowd were each 50% co-owners of Green Hills Software Inc., an S corporation. Their relations with each other deteriorated until 1998, when O'Dowd triggered a dispute-resolution provision in the shareholder agreement. It provided for binding arbitration and that either party could force a buyout of the other's stock based on a formula price. Hightower was unable to raise the funds to buy out O'Dowd's shares, so he was forced to sell his shares to O'Dowd. Hightower received the buyout check in 2000, deposited it in an interest-bearing account and sought to have the sale set aside in court. By 2003, Hightower had lost in state court and had exhausted all appeal opportunities. Meanwhile, he had not reported his pass-through distributive share of Green Hills' 2000 income, any of the gain from the forced buyout payment or the interest received from its invested proceeds.

The courts dismissed Hightower's contention that the gain escaped tax under the claim-of-right doctrine until 2003. …