## Facts

- Raymond J. Paige and Patricia C. Paige acquired shares in Tackmer Corporation, a small California corporation formed in 1965.
- The Paiges received Tackmer stock in exchange for assigning their rights in an exclusive license agreement (the “property shareholders”).
- Other Tackmer shareholders received their shares by paying cash (the “cash shareholders”).
- Tackmer’s articles of incorporation stated that no distinction would exist between the corporation’s shares or their holders.
- California corporate law permitted shares to be treated as indistinguishable unless distinctions were stated in the articles, but California also required a permit to issue stock and authorized the California Department of Corporations to impose conditions to protect investors.
- Because Tackmer issued stock for both cash and noncash property of uncertain value, the Department imposed protective conditions intended to prevent dilution of the cash investors’ interests.
- The conditions (which the Paiges agreed to in writing) included:
  - Stock escrow and transfer limits (shares placed in escrow and not transferable without the Department’s consent).
  - A contingency affecting control: if dividends were unpaid for two years, the cash shareholders would receive an irrevocable proxy to vote the property shareholders’ shares for the board of directors.
  - Distribution preferences: on dissolution, the property shareholders had to waive distribution rights until the cash shareholders recovered their purchase price plus unpaid accumulated dividends at 5% per year; the conditions also gave the cash shareholders superior rights regarding dividends and asset distributions.
- Tackmer elected Subchapter S treatment, and the Paiges sought pass-through reporting of Tackmer’s income and losses on their individual returns.
- The Commissioner disallowed the Subchapter S treatment on the ground that Tackmer had more than one class of stock, assessed additional tax, and the Paiges paid and sued the United States for a refund in federal district court.
- The district court entered judgment for the United States, and the Paiges appealed to the Ninth Circuit.

## Issues

1. Whether the “one class of stock” requirement for Subchapter S eligibility is determined under federal tax law rather than by state corporate-law labels or the corporation’s articles.
2. Whether the California Department of Corporations’ permit conditions—granting the cash shareholders superior dividend, liquidation, and contingent voting rights—created more than one class of stock and therefore disqualified Tackmer from Subchapter S status.

## Decision

- The Ninth Circuit affirmed the district court’s judgment for the United States and denied the Paiges’ refund claim.
- The court held that Subchapter S qualification requirements, including the “one class of stock” requirement, are questions of federal tax law.
- The court held that the permit conditions created materially different rights between the cash shareholders and the property shareholders, resulting in more than one class of stock for Subchapter S purposes.
- Because Tackmer had more than one class of stock, it was not eligible for Subchapter S treatment, and the IRS properly disallowed pass-through reporting.

## Legal Principles

- Federal tax law governs whether a corporation satisfies Subchapter S eligibility requirements; state corporate-law characterizations and labels do not control the federal determination.
- For purposes of the Subchapter S “one class of stock” requirement, the analysis focuses on the actual rights attached to the shares—especially rights to dividends, liquidation proceeds, and voting control—rather than on formal statements in the articles.
- Rights and restrictions imposed through regulatory permit conditions, when accepted and binding on shareholders, are part of the operative share rights for federal tax characterization.
- Preferential economic rights (such as distribution priorities or a return of capital preference) and contingent control rights (such as voting power shifts on dividend default) can create a second class of stock and defeat Subchapter S eligibility.

## Conclusion

In *Paige v. United States*, the Ninth Circuit held that federal tax law controls the Subchapter S “one class of stock” inquiry and that the California Department of Corporations’ permit conditions gave cash shareholders preferential dividend and liquidation rights and a contingent voting advantage over property shareholders; those differences created more than one class of stock, making Tackmer ineligible for Subchapter S and defeating the Paiges’ tax refund claim.


Paige v. United States, 580 F.2d 960 (1978)