Financial Services Firm Can't Exclude 9/11 State Grant Proceeds from Income

(Parker Tax Publishing March 2025)

The Tax Court held that New York state grant proceeds received by a financial services corporation as a result of the September 11, 2001, terrorist attacks on the World Trade Center were not excludible from income. The court concluded that the grant proceeds (1) were not excludable under Code Sec. 118 as a contribution to capital because the taxpayer did not show that the proceeds became part of its working capital; (2) did not qualify as nontaxable gifts under Code Sec. 102 because transfers of property by a governmental entity to its constituents are not considered gifts; and (3) were not qualified disaster relief payments under Code Sec. 139(a) because that exclusion applies only to individuals. CF Headquarters Corporation v. Comm'r, 164 T.C. No. 5 (2025).

Background

During 2007, CF Headquarters Corporation (CFH) was wholly owned by Cantor Fitzgerald, L.P. (Cantor Fitzgerald), a domestic partnership and the parent entity of numerous financial services subsidiaries (Cantor Group). One of those subsidiaries occupied floors 101 through 105 of the north tower of the World Trade Center in New York City (NYC). Six hundred and fifty-eight of the firm's approximately 1,000 employees were killed in the September 11, 2001, terrorist attacks.

In response to the attacks, the Empire State Development Corp. (Empire State), in cooperation with the New York City Economic Development Corp., established the World Trade Center Job Creation and Retention Program (JCRP) to provide grants to affected businesses. To be eligible for JCRP grants, companies were generally required to create or retain at least 200 full-time jobs in lower Manhattan or NYC for a period of at least seven years. Grant proceeds were awarded after a company demonstrated that it had complied with its employment commitment and that it had incurred expenses after September 11, 2001, in one of five eligible categories related to employment: (1) wages; (2) payroll taxes; (3) employee benefits; (4) rent; and (5) movable equipment and furniture. All funds disbursed under the JCRP were subject to recapture if the employment requirement was not met.

In November of 2003, Cantor Fitzgerald received a $6 million JCRP grant. In January of 2007, Cantor Fitzgerald and Empire State entered into an Amended and Restated Grant Disbursement Agreement (ARDA) that authorized a JCRP grant totaling $8.55 million. The ARDA prescribed that grant proceeds were to be used by CFH solely for expenses in the eligible categories incurred after September 11, 2001.

In the ARDA, Cantor Fitzgerald committed to retain at all times, subject to recapture of the grant proceeds, at least 643 full-time employees in NYC, with at least 250 of them being employed in lower Manhattan. The ARDA referred to these baselines as the "minimum employment number" and "south of canal zone minimum employment number." Failure to maintain either of these minimum levels of employment for ten years authorized Empire State to recapture some or all of the proceeds that had already been disbursed.

For each job it created and retained south of the canal zone above the baseline amount at the time of its request, Cantor Fitzgerald became entitled to an additional disbursement of $10,000. For each job created and retained in NYC but not south of the canal zone, Cantor Fitzgerald became entitled to an additional disbursement of $7,500.

Attached as an exhibit to the ARDA was a risk analysis performed to determine the fiscal impact, including to state and city tax revenues, if Cantor Fitzgerald had chosen to move its business outside NYC. The parties estimated that Cantor Fitzgerald generated approximately $9.8 million and $10.5 million of tax revenue annually for NYC and the State of New York, respectively.

On September 24, 2007, CFH requested a disbursement from Empire State of grant proceeds pursuant to the ARDA. It attached a report indicating that it had met its minimum employment commitments. On November 28, 2007, Empire State made an additional disbursement of $3,107,500 to CFH as reimbursement for rent expenses.

Because CFH is a holding company, it paid no wages, salaries, employee benefits, or rent in 2007. On its 2007 tax return, it reported interest income generated by intercompany loans that involved grant proceeds, and almost $400,000 of income tax. It did not include in gross income the $3,107,500 in grant proceeds received.

Upon auditing CFH's 2007 return, the IRS determined that CFH (1) was required to include the grant proceeds in its gross income, and (2) was liable for an accuracy-related penalty under Code Sec. 6662(a) and Code Sec. 6662(b)(2) for a substantial understatement of income tax.

CFH argued that the grant proceeds were excludable from income under Code Sec. 118 as a contribution to the capital of a corporation or, in the alternative, as a gift under Code Sec. 102, or as a qualified disaster relief payment under Code Sec. 139. CFH also contended that it was not liable for the accuracy-related penalty because it had substantial authority for its position and cited: (1) the Supreme Court's holding in Edwards v. Cuba Railroad Co., 268 U.S. 628 (1925) (Cuba Railroad), that payments authorized by the Cuban government to a New Jersey corporation were not income; (2) the fact that no pronouncement from Congress has classified grants under the JCRP as income; and (3) the ARDA did not include anything stated or implied indicating that the grant proceeds were income.

The IRS contended that the grant proceeds were not excludable under any relevant statutory provision. The IRS discounted CFH's reliance on Cuba Railroad, noting that since deciding that case, the Supreme Court had issued several decisions which negated CFH's reliance on Cuba Railroad. In particular, the IRS cited the Court's decision in U.S. v. Chicago, Burlington & Quincy R.R. Co. (CB&Q), 412 U.S. 401 (1973), as distinguishing Cuba Railroad. In CB&Q, the Court held that government payments made in furtherance of a public benefit are not per se capital contributions but rather are subject to further inquiry.

Analysis

The Tax Court disagreed with all three of CFH's arguments and held that the grant proceeds were includible in CFH's 2007 income. In CB&Q, the court said, the Supreme Court analyzed the precodification decisions regarding Code Sec. 118 and found that for a transfer to qualify as a contribution to capital under Code Sec. 118(a), the transferor must intend it as such. The Tax Court observed that the Supreme Court identified the following five possible "characteristics" of a nonshareholder contribution to capital to determine intent when it is not readily apparent from the evidence: (1) the contributed asset(s) become part of the transferees permanent working capital; (2) the contributed asset(s) cannot be compensation for direct, quantifiable services rendered; (3) the contributed asset(s) must be bargained for; (4) the contributed asset(s) must foreseeably result in a benefit to the transferee in an amount commensurate with its value; and (5) the contributed asset(s) will be employed in or contribute to the production of additional income.

The Tax Court agreed with the IRS that CFH's Code Sec. 118 argument did not work because CFH could not show that the grant proceeds became part of its working capital. Additionally, the Tax Court noted that the Third Circuit, in Comm'r v. BrokerTec Holdings, Inc., 2020 PTC 224 (3d Cir. 2020), thoroughly reviewed the case law regarding the application of Code Sec. 118 in a case involving a similar Code Sec. 118 dispute. The Third Circuit found that the grantor in that case did not intend that the grant proceeds be a contribution to capital. The taxpayer in BrokerTec Holdings, Inc., the Tax Court observed, could not show that the proceeds became a permanent part of its working capital because the grant proceeds were not explicitly restricted for use in the acquisition of capital assets. The Tax Court agreed with the Third Circuit's conclusion that unrestricted government payments and payments based on a company's income, rather than the amount of capital investment made by the company, indicate an intent to provide income.

The Tax Court also rejected CFH's argument that the grant proceeds were a gift from the government. First, the court said, the evidence established that Empire State's motive for providing the grant proceeds was not detached and disinterested generosity but instead the pursuit of commitments of increased employees. Second, after reviewing the funding legislation and associated legislative history, the court was persuaded that Congress did not possess the requisite donative intent for the court to consider the grant proceeds a gift under Code Sec. 102.

Finally, the court noted that Code Sec. 139(a) provides that gross income does not include any amount received by an individual as a qualified disaster relief payment. Thus, the court concluded, since the grant proceeds at issue were not paid to an individual, Code Sec. 139(a) did not apply to CFH.

With respect to the penalty assessment, CFH fared much better as the court concluded that there was substantial authority for CFH's treatment of the grant proceeds based on its reasonable application of several decisions of the Supreme Court, the statutory text of Code Sec. 118 as it existed at the time, and the regulations thereunder. The court also noted that Code Sec. 118 has been amended since the year at issue to clarify that certain contributions made by governmental entities are not treated as contributions to capital. Accordingly, the court held that CFH was not liable for the Code Sec. 6662(a) penalty.

For a discussion of the general rule for contributions to the capital of a corporation, see Parker Tax ¶77,501. For a discussion of the abatement of penalties due to reasonable cause, see Parker Tax ¶262,127.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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