## Facts

- Ocean Shores Bowl, Inc., a Washington corporation formed in 1962, issued only one class of stock.
- The corporation timely elected small business corporation (Subchapter S) status for 1962, and consents were filed by all shareholders of record and their spouses.
- Shareholders claimed pass-through deductions for the corporation’s net operating losses for 1962 and 1963 on their individual returns.
- 125 shares and related debentures were issued in the name of William MacPherson, but the purchase was funded with a corporate check from MacPhersons, Inc. and charged equally to the drawing accounts of William and his brother Murdock.
- The brothers treated the investment as jointly owned in later tax reporting, including splitting loss deductions and later reporting sale items consistent with each owning one-half.
- The Commissioner determined Murdock was a beneficial owner of one-half of the 125 shares and thus a “shareholder” whose written consent was required; because he had not consented, the Commissioner treated the Subchapter S election as defective and disallowed the loss pass-through deductions.
- The Tax Court agreed the election was invalid for lack of unanimous shareholder consent (including beneficial owners) and declined to allow late consents to cure the defect.

## Issues

1. Whether “shareholder” for Subchapter S unanimous-consent purposes includes beneficial owners of stock not shown as record owners.
2. Whether the Tax Court properly drew an adverse inference from the taxpayers’ failure to call the corporate bookkeeper/tax preparer as a witness.
3. Whether the IRS abused its discretion in refusing to grant an extension of time to file consents to perfect an otherwise defective Subchapter S election.

## Decision

- The Ninth Circuit held that, for Subchapter S purposes, beneficial ownership determines who is a “shareholder,” and Murdock was a shareholder as to one-half of the shares titled in William’s name.
- Because Murdock did not consent, the original election was defective for lack of unanimous shareholder consent, and the Tax Court’s ruling on that point was affirmed.
- The court upheld the Tax Court’s adverse inference that the uncalled bookkeeper’s testimony would likely have been unfavorable to the taxpayers.
- The court held the District Director abused discretion by denying additional time to file the missing consent where reasonable cause existed and denial caused hardship; the taxpayers were entitled to an opportunity to cure by late consents.

## Legal Principles

- For Subchapter S election requirements, “shareholder” is determined under federal tax law and includes beneficial owners who bear the benefits and burdens of ownership, even if they are not shareholders of record.
- Treasury regulations treating as shareholders those who would be required to include dividends in gross income are valid and may be used to identify shareholders for unanimous-consent rules.
- A court may sustain an adverse inference against a party who fails to call an available witness with special knowledge when the circumstances support the inference.
- The IRS has regulatory discretion to grant extensions for filing shareholder consents; refusing an extension despite reasonable cause, resulting in undue hardship, can constitute an abuse of discretion.

## Conclusion

The court affirmed that Subchapter S elections require unanimous consent from all shareholders, including beneficial owners, but ruled that the IRS acted unreasonably in refusing to allow late consents to correct the defect where the omission was understandable and denial would defeat the intended tax treatment.


Kean v. Commissioner, 469 F.2d 1183 (9th Cir. 1972)