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The Internal Revenue Code of 1954, 26 U.S.C.S. § 482 authorizes the Internal Revenue Commissioner to reallocate income or deductions among commonly controlled businesses if he determines that such allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such businesses.
In 1955, Jack Foster and his three sons formed a partnership, T. Jack Foster and Sons (Partnership), for the general purpose of dealing in property, with Jack as the managing partner. In 1958, the Partnership began to investigate the reclamation potential of Brewer's Island, a 2,600 acre undeveloped and partially submerged tract of land located about 12 miles south of San Francisco. After commissioning engineering studies, the Partnership determined that the tract could be transformed into a self-contained city (Foster City) of 35,000. In December, 1959, the Partnership acquired an option to purchase the property for $12.8 million; in May, 1960, it secured enabling legislation from the California legislature for a municipal improvement district known as Estero, which was coterminous with Brewer's Island; and, in August, 1960, it exercised its option to purchase the tract. Thereafter, the Partnership and Estero began developing the property by neighborhood. The Commissioner of Internal Revenue issued notices of deficiency to the Fosters for the years 1963-67 concerning their role in the development of Foster City. The Fosters appealed the United States Tax Court's affirmance of the Commissioner's determination.
Did the Commissioner have the authority to reallocate income after its determination that the Fosters owed a tax deficiency to the IRS based on their transfer of partnership property into corporations allegedly created for tax-avoidance purposes?
The court found that the Fosters’ transfer of property and income was an incorrect method of avoiding partnership taxation. The Commissioner had the authority to reallocate income after such transfers. The land that the Fosters set aside for a school could not be deducted as a charitable contribution. However, the court found that the Fosters’ behavior was not intentional. Therefore, the court affirmed in part and vacated in part the Commissioner's determination.