Santa Clara Valley Housing Group, Inc. v. United States

Santa Clara Valley Housing Group, Inc. (Santa Clara) (plaintiff) was a closely held corporation created in 2000. At the time of incorporation, all of the Santa Clara stock, consisting of 100 voting shares and 900 non-voting shares, was held by members of the Schott family. In June 2000, using the S Corporation charitable-contribution strategy, each Schott family member received a warrant to purchase 10 non-voting shares for every non-voting share held. Later in 2000, the Schott family collectively donated 900 non-voting shares to a nonprofit, the City of Los Angeles Safety Members Pension (LASMP), with an understanding that the shares would be sold back to the Schott family members after a specified period of time. This strategy was devised to exclude any profits of Santa Clara from taxation during the period the nonprofit held the majority of shares. The warrants were intended to ensure the Schott family was able to return to control of Santa Clara even if LASMP was unwilling to return the shares to the family. In 2004, the Santa Clara shares were sold back to the Schott family for over $1.6 million. The warrants were cancelled in 2006. After auditing Santa Clara and the Schott family members, the Internal Revenue Service issued a deficiency notice for over $600,000 in taxes and penalties for 2000. Santa Clara appealed. Santa Clara and the government filed motions for summary judgment on the issue of whether the issuance of the warrants terminated Santa Clara’s status as an S corporation. The court determined that the warrants were a second class of stock. Santa Clara filed a motion for reconsideration, arguing that the warrants should be considered options exempted from classification as a second class of stock, pursuant to safe-harbor provisions.