Rafferty v. Commissioner

Joseph Rafferty (plaintiff) owned several profitable steel companies, which, in turn, owned the real estate on which they operated. Rafferty wished for his sons, but not his daughters or sons-in-law, to eventually take control of the steel companies. However, Rafferty still wished to have the steel companies provide economic support to his daughters. Rafferty performed a series of transactions at the suggestion of his accountant meant to achieve this result. Rafferty organized Teragram Realty Company (Teragram) and had his steel companies contribute all their real estate assets to it in exchange for Teragram’s stock. Teragram then leased back the real estate to the companies. At all relevant times, the real estate assets were marketable and could have been sold for cash to a third-party buyer. Additionally, there was no business benefit to the steel companies for Teragram’s existence. After several years of Teragram accumulating substantial earnings, Rafferty had the steel companies distribute all of their Teragram shares to him. Rafferty then planned to gift or bequeath the Teragram shares to his daughters. Rafferty treated the distribution of the Teragram shares as tax-free. The Internal Revenue Service (IRS) (defendant) disagreed, claiming that the distribution was used principally as a device to avoid taxes. Rafferty brought the case to the United States Tax Court, which ruled in favor of the IRS. Rafferty appealed.