Unpublished Disposition, 899 F.2d 1225 (9th Cir. 1986)

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US Court of Appeals for the Ninth Circuit - 899 F.2d 1225 (9th Cir. 1986)

Tirey L. HUME; Margaret K. Hume, Petitioners-Appellants,v.COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 89-70195.

United States Court of Appeals, Ninth Circuit.

Submitted April 10, 1990.* Decided April 13, 1990.

Appeal from a Decision of the Tax Court of the United States.





Tirey L. Hume ("Hume") appeals pro se the decision of the United States Tax Court finding deficiencies in his income tax payments for the years 1974 and 1975. Hume contends that the Tax Court erred in determining that Columbia Forge and Machine Works, Inc. ("Columbia") was a Subchapter S corporation and that Hume, as a shareholder, was required to report his share of the undistributed taxable income of Columbia on his personal income tax returns.

The Tax Court had jurisdiction pursuant to 26 U.S.C. §§ 6213(a) and 7442. We have jurisdiction pursuant to 26 U.S.C. § 7482 and affirm.

* The Commissioner of the Internal Revenue Service issued a notice of deficiency to Tirey L. Hume and Margaret K. Hume for the years 1974 and 1975. The deficiency resulted from the Humes' failure to include on their personal income tax return the undistributed taxable income and dividends reported by Columbia Forge and Machine Works, Inc. at the close of its fiscal years on January 31, 1974 and January 31, 1975. Columbia is a welding and forging business which had three shareholders at the time of its incorporation, namely, Louis McMullin ("McMullin"), Jack E. Orr ("Orr") and Hume. Each owned 100 shares (one third) of the stock of the corporation. Columbia elected to be taxed as a qualified small business corporation under Subchapter S of the Internal Revenue Code, 26 U.S.C. §§ 1371-1379 (1972).

On August 12, 1971, McMullin and Orr entered into a Stock Sale Agreement ("Agreement") with The Skookum Company, Inc. ("Skookum") which provided that Skookum would lease certain properties to Columbia in exchange for an option to purchase Columbia stock either upon the death of Orr or McMullin, or upon the initiative of either one of them.

McMullin died on December 14, 1973. On January 10, 1974, his estate and Orr executed a Supplemental Agreement with Skookum extending the option period until February 1, 1975. The actual transfer of the McMullin shares to Skookum occurred on May 30, 1975.

Columbia filed its income tax returns for fiscal years ending January 31, 1974 and January 31, 1975 as a Subchapter S corporation. It also issued K-1 forms to all three shareholders. The K-1 forms issued to Hume reported his share of the undistributed taxable earnings of Columbia to be $31,305.58 for 1974 and $521.83 for 1975 as well as a dividend distribution of $53,666.69 for 1975. Hume's income tax returns for 1974 and 1975 did not report any undistributed taxable income or dividend income from Columbia.


Item 15 in the Supplemental Stipulation of Facts, filed herein on September 22, 1986 and signed by both parties, states that "the only issue for resolution in this case is whether the status of Columbia Forge and Machine Works, Inc. as a qualifying Subchapter S Corporation was terminated for the fiscal years ended January 31, 1974 and January 31, 1975 based upon an alleged transfer of stock to the Skookum Company, an Oregon Corporation."

Hume contends that when the Agreement was executed on August 12, 1971, Skookum became the owner of two-thirds of the stock of Columbia and since Skookum was not an individual, the Subchapter S status of Columbia terminated at that time, see 26 U.S.C. § 1371(a) (2) (for the purposes of Subchapter S status a corporation may not "have as a shareholder a person (other than an estate) who is not an individual").

Hume relies on section 318(a) (4) of the Internal Revenue Code to support his argument that the option agreement transferred stock ownership to Skookum.1  His reliance is misplaced. Section 318 is limited to provisions of Subchapter C which expressly make section 318 applicable. Hume has failed to indicate any provision specifically making this section applicable to his case.2 

An option to purchase stock does not transfer ownership until such time as the option is exercised. See Walker v. C.I.R., 544 F.2d 419, 422 (9th Cir. 1976) (seller held to be the beneficial owner of stock and responsible for taxes on a dividend which was declared earlier on the same day that buyer exercised his option to purchase the stock); Danenberg v. C.I.R., 73 T.C. 370, 389-392 (1979) (beneficial ownership of stock was transferred on the effective date of the sale agreement rather than on the date the agreement was signed).

Paragraph 5 of the Agreement with Skookum specified that after its execution, McMullin and Orr would retain all the rights of ownership.3  Skookum had no title to, or beneficial rights in, the McMullin/Orr stock until Skookum exercised its option by giving notice of intent to buy, completing a valuation audit, and appointing an escrow agent to take custody of the stock. Because none of these actions occurred prior to February 1, 1975, Columbia retained its Subchapter S status for fiscal years ending January 31, 1974 and 1975. Accordingly, Hume, as a shareholder, was obligated to report dividends and undistributed income on his personal income tax returns for 1974 and 1975.


The decision of the Tax Court is AFFIRMED.


The panel finds this case appropriate for submission without oral argument pursuant to Ninth Circuit Rule 34-4 and Fed. R. App. P. 34(a)


This disposition is not appropriate for publication and may not be cited to or by the courts of this circuit except as provided by 9th Cir.R. 36-3


Section 318 is located in Subchapter C and deals with constructive ownership of stock. The pertinent parts provide as follows:

(a) For purposes of those provisions of this subchapter to which the rules contained in this section are expressly made applicable--

* * *

(4) If any person has an option to acquire stock, such stock shall be considered as owned by such person.

26 U.S.C. § 318 (1972).


We agree with the Tax Court that the constructive ownership rules are intended to apply to family, partnership, estate, and trust situations where there is a likelihood that someone in one of those categories would exercise influence over the nominal owner


Paragraph 5 of the Agreement provides for notification of the existence of the option by an endorsement on the Orr and McMullin stock certificates and then states that "after endorsement the certificates shall be returned to the shareholders, who shall, subject to the terms of this agreement, be entitled to exercise all the rights of ownership of such stock, subject however, to this agreement."