Taxpayer was the 75% owner of an S corporation that designed, assembled, and sold gift baskets and gift towers through wholesale and retail channels. A gift tower is a set of decorative boxes that contain different food items. In this action, the IRS sought to recover refunds paid to taxpayer based on a Section 199 deduction claimed by the S corporation on its amended tax returns for 2005 and 2006. In allowing taxpayer to keep the refunds, a California District Court agreed that the S corporation's production process "changed the form of an article" within the meaning of Reg. 1.199-3(e)(1) . The "complex production process relied on both assembly line workers and machines. The final products, gift baskets and gift towers, [were] distinct in form and purpose from the individual items inside." That is, the production process transformed individual items typically purchased by consumers as ordinary groceries into gifts that were usually given during the holiday season. U.S. v. Dean , 112 AFTR 2d 2013-XXXX (DC Central Cal.).
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