In Trawick Construction Co. v. Georgia Dept. of Revenue, ____ S.E.2d ___, 2010 WL 678937 (Ga. Mar. 1, 2010), the Georgia Supreme Court reversed a Georgia Court of Appeals decision and held that gain from a deemed asset sale was not subject to Georgia corporate income tax. The taxpayer was a closely held Florida corporation treated as a Subchapter S corporation for federal income tax purposes. All of its shareholders were Florida residents. Georgia law does not conform to the federal “S” election and requires that all shareholders consent to Georgia taxation before an “S” election is recognized. OCGA § 48-7-21(b)(7). By not making a separate Georgia S election, the taxpayer was a Subchapter C corporation for Georgia income tax purposes.
In 1999, the taxpayer’s shareholders sold all of their stock to a third party who agreed to make an election under IRC § 338(h)(10) to treat the transaction for federal tax purposes as a deemed asset sale. The issue before the Court was whether this federal election applied for Georgia income tax purposes and whether the gain on the transaction was subject to Georgia tax. If the election applied, as the Department contended, the taxpayer would have fictionally sold its assets, received the income from the sale of these assets, and distributed the asset sale proceeds to its shareholders. The Department contended that this income was apportionable business income and that the taxpayer was taxed as a corporation. The taxpayer argued that the transaction should be treated as the sale of the taxpayer’s stock.
O.C.G.A. § 48-7-21(b)(7) provides that “All elections made by corporate taxpayers under the Internal Revenue Code …shall also apply under this article except elections involving consolidated corporate returns and Subchapter “S” elections…” (emphasis added). The taxpayer argued, and the Court agreed, that an IRC § 338(h)(10) election is not made “by the corporate taxpayer” but instead is made by the corporation’s shareholders. Therefore, the federal election did not apply for Georgia tax purposes and the transaction was correctly treated for Georgia income tax purposes as the sale of stock by the corporation’s shareholders.
However, the Court did indicate that the new shareholders of the taxpayer may not get the benefit of a stepped-up asset basis in stock for Georgia income tax purposes because the S election did not apply. This would result in different basis for the acquired entity’s assets for federal and state tax purposes.
Although this case was a matter of first impression in Georgia, the Court’s holding is consistent with that of the New York Tax Court in In the Matter of the Petition of Gabriel S. and Frances B. Baum, Determination DTA Nos. 820837 and 820938 (Dec. 20, 2007) but inapposite of the holding by the New Jersey Tax Court in General Building Products Corp. v. New Jersey Division of Taxation, 14 N.J. Tax 232 (1994).