Kean v. Commissioner

Ocean Shores Bowl (Ocean Shores) was a Washington corporation. In 1962 Ocean Shores filed an election pursuant to § 1362 of the Internal Revenue Code to be taxed as an S corporation by the consent of its shareholders (plaintiffs). After electing for Ocean Shores to be an S corporation, the shareholders deducted their pro rata share of Ocean Shores’ losses on their personal 1962 and 1963 income-tax returns. One of the shareholders was William MacPherson, who owned 125 shares of Ocean Shores stock. William and his brother, Murdock MacPherson, coowned a real estate company called MacPhersons, Inc., and made many investments together. William’s Ocean Shores shares were purchased with a check from MacPhersons, Inc. Even though Murdock was not a shareholder of record in Ocean Shores and did not participate in the Subchapter S election, he deducted one-half of William’s pro rata share of Ocean Shores’ operating losses on his 1962 and 1963 income-tax returns. In 1965, after an Internal Revenue Service audit discovered these facts about Murdock, the Commissioner of Internal Revenue (the Commissioner) disallowed the deductions taken by all the Ocean Shores shareholders. The Commissioner reasoned that Murdock was a beneficial owner of Ocean Shores stock and, as a result, the election by the shareholders to convert Ocean Shores into an S corporation was invalid because it did not receive unanimous consent from the shareholders. The shareholders argued that because Murdock was not a shareholder of record, he was not a shareholder for purposes of the Subchapter S election. The United States Tax Court agreed with the Commissioner’s determination and disallowed the loss deductions. The tax court also denied the shareholders’ request to extend the deadline for the shareholders to file a valid election. The shareholders appealed.