## Facts

- Carl A. Pescosolido, Sr. controlled several closely held corporations and consolidated them into Lido Corporation of New England, Inc. as part of a recapitalization and restructuring.
- Lido issued nonvoting preferred stock to Pescosolido; counsel obtained an IRS ruling letter that the preferred stock would be treated as “§ 306 stock” under the Internal Revenue Code.
- Within five years of issuance, Pescosolido donated shares of this § 306 stock to Deerfield Academy and Harvard College.
- The stock was closely held and had no public market; the parties stipulated a fair market value of $100 per share.
- Over 1978–1980, the taxpayers donated 1,500 shares and claimed charitable contribution deductions based on fair market value (total $150,000).
- The Commissioner determined that, because a sale of § 306 stock would generate ordinary income under § 306(a), § 170(e)(1)(A) required reducing the charitable deduction by the ordinary-income component, effectively limiting the deduction to cost basis unless a § 306(b) exception applied.
- The Commissioner issued deficiency notices for 1978–1980 disallowing the excess deductions and asserted a negligence addition for 1980, later conceding the negligence addition; litigation proceeded on the deduction amounts.

## Issues

1. Whether charitable contribution deductions for donated § 306 stock are allowable at fair market value or limited to the taxpayers’ cost basis under § 170(e)(1)(A).
2. Whether the taxpayers proved the § 306(b)(4) exception—that the distribution and disposition of the § 306 stock were not pursuant to a plan with a principal purpose of federal income tax avoidance—so that § 306(a)’s ordinary-income characterization would not apply.

## Decision

- The Tax Court held that the taxpayers did not establish that the issuance and charitable disposition of the § 306 stock were not pursuant to a plan with a principal purpose of avoiding federal income tax within the meaning of § 306(b)(4).
- Because § 306(a) would have caused ordinary income on a hypothetical sale, § 170(e)(1)(A) limited the charitable contribution deductions to the taxpayers’ cost basis in the donated shares.
- The court sustained the Commissioner’s disallowance of deductions above basis, reflecting the Commissioner’s concession of the negligence addition.

## Legal Principles

- Section 170(e)(1)(A) reduces a charitable deduction for contributed property by the amount of gain that would be ordinary income if the property were sold; for ordinary-income property, the practical effect is a deduction limited to basis.
- Section 306(a) generally treats gain on disposition of § 306 stock as ordinary income to prevent using preferred stock to extract corporate earnings and profits in tax-favored form.
- A taxpayer seeking to avoid § 306(a) under § 306(b)(4) bears the burden to prove that both the distribution of the § 306 stock and its disposition were not pursuant to a plan having as one of its principal purposes the avoidance of federal income tax.
- Evidence of bona fide charitable intent does not, by itself, satisfy § 306(b)(4) if the overall arrangement supports a principal tax-avoidance purpose.

## Conclusion

The Tax Court limited the taxpayers’ charitable deductions for donated § 306 stock to cost basis under § 170(e)(1)(A) because the taxpayers failed to prove that the issuance and charitable transfer were outside a plan with a principal purpose of avoiding federal income tax under § 306(b)(4).


Pescosolido v. Commissioner, 91 T.C. 52 (1988)