Originally Published on forbes.com on January 4th, 2012
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Appreciated assets inside a closely held C corporation in a taxable estate – If there is a certain formula for making a small fortune, by starting with a large fortune, that might be it. That was the situation that Carol Parks, daughter of Boston taxi magnate Frank Sawyer, faced in 2000 when her mother died.
Frank Sawyer was a real rags to riches story. He had a an eighth grade education. He shined shoes and sold newspapers till he saved up enough money to buy a cab. Ultimately through his corporations he would own more Boston taxi medallions than anyone. (The medallions issued in limited numbers by the city appreciated mightily from the $50 originally paid for them in the thirties.) According to this story in Boston Magazine in 2004, Edward Tutunjian, who then owned 20% of Boston’s 1825 medallions had purchased over half of them from Sawyer family entities in 2000, one of the critical transactions in this recent Tax Court decision. (Mr. Tutunjian was still buying Boston medallions in 2009 according to this story , at $362,500 each). Mr. Sawyer had been involved in rental car operations and served as chairman of Avis. Mr. Sawyer also had operated parking lots and owned choice Boston real estate – again inside of C corporations. He died in 1992 at the age of 97. His wife Mildred died in 2000. Included in her estate was the Frank Sawyer Trust of 1992 where all those medallions were parked. The taxable estate of $138,480,721 generated $76,600,416 in federal and state transfer taxes.
Some of the money would come, indirectly, from selling the medallions owned by Town Taxi and Checker Taxi mostly to Mr. Tutunjian for about $36,000,000. Since the basis in the medallions was negligible, that would make for a lot of corporate capital gains tax. That is where Midcoast Credit Corp and Fortrend International LLC came into the picture. They offered a sweet deal. Have the corporations make the sale and pay off all debts. They would then buy the taxi corporations for cash on hand (now the sole asset) less a percentage of the presumed liability for corporate income taxes. Ms. Parks, the trustee, and her advisers were apparently not all that curious as to how Midcoast and Fortrend were going to make this work out. I hate to second guess people, not knowing the constraints they were operating under, but it does not seem that they had done a cracker jack job of tax planning up to this point. It would seem that an S election would have been in order in 1986, but who knows the obstacles that might have been in the way that you would have to explain to a 91 year old guy ? Regardless, I can accept that the Sawyer family interests had no reason to think that Midcoast and Fortrend did not have legitimate strategies for managing the corporate tax obligations, which were no longer the problem of the Frank Sawyer Trust. Of course, the IRS can be a little more hard-nosed than I am.
There were also two other corporations that owned real estate where a similar arrangement was made. For the sake of simplicity I’ll just stick with the taxi companies :
From October 13 through December 29, 2000, Fortrend caused Checker Taxi to make numerous transfers, resulting in a yearend account balance of $308,639. Similarly, Fortrend caused Town Taxi to make various transfers resulting in a yearend account balance of $93,602. None of these transfers were made to the Trust. Moreover, before the closing of the Taxi corporations’ 2000 tax year, a Fortrend-controlled entity transferred Trex Communications stock to Town Taxi and Checker Taxi and also transferred Paclaco Equities stock to Checker Taxi.
Fortrend caused the Taxi corporations to each file Form 1120, U.S. Corporation Income Tax Return, for the taxable year ended December 31, 2000. With respect to the sale of its taxi medallions, Town Taxi reported on Schedule D, Capital Gains and Losses, proceeds of $18,468,900 and a cost basis of $2,740,000, resulting in a recognized long-term capital gain of $15,728,900. Additionally, Town Taxi reported a long-term capital loss of $18,495,188 from the disposition of Trex Communications stock. This resulted in Town Taxi’s reporting a net long-term capital loss of $2,766,288.
Checker Taxi’s Schedule D reported proceeds of $17,578,000 and a cost basis of zero with respect to the sale of its taxicab medallions, resulting in a recognized long-term capital gain of $17,578,000. Moreover, Checker Taxi’s reported long-term capital losses of $13,097,812 and $3,766,154 from the disposition of Trex Communications stock and Paclaco Equities stock, respectively. This resulted in Checker Taxi’s reporting a net long-term capital loss of $714,034.
So what Fortrend did was strip the cash out and contribute stock in a related company. The stock in the related company was sold at a large enough loss to offset the gain on the medallions. Only that loss turned out not to be real. This was conceded when the companies were audited. Of course at this point there are no longer assets in the taxi companies. So the IRS started looking for other people to collect the tax from. This is not the only sketchy transaction that Fortrend was involved in. As a matter of fact the finders fee for the Sawyer transaction ($275,800) was paid out of another company called St. Augustine, that was the subject of a similar transaction. The consultant (CHC Industries) had to pay the fee proceeds to the IRS in satisfaction of some of St. Augustine’s taxes. CHC tried to argue that the payment was really from Fortrend, for whom they had rendered services, but the Court did not buy that argument.
The IRS wanted to collect the tax on the medallion gains from the Sawyer Trust. The problem that the IRS had is that the Sawyer trust did not take anything from the taxi corporations. Fortrend borrowed from a bank in order to pay the Sawyer trust. The loan from the bank was rather transitory, but that was not something that the Trust was privy to. The IRS wanted to collapse all the transactions ignoring the bank loan and Fortrend stripping the cash and act as if Sawyer trust received its payments from the corporations it owned. Under the Uniform Fraudulent Transfer Act, though, the burden was on the IRS to prove that the trustee knew that Fortrend’s schemes were not legitimate.
We must first determine whether the trust had actual knowledge. Respondent stipulated for all of the stock sales that at the time of the stock sales neither Ms. Parks nor the trust representatives knew about the postclosing merger or the contribution of inflated-basis stock contemplated by Fortrend. Reviewing this stipulation and the record as a whole, we do not find that the trust had actual knowledge.
Brian Lovett and Tony Nitti, who also wrote about this case, titled their post Ignorance is Bliss. This was a great holiday season for the Sawyer family. Just before Thanksgiving they dodged foreclosure on the luxury Residences at W Boston, a Boston theatre district development they had backed. Then right after Christmas, the Tax Court removed this 20+ million sword of Damocles that had been hanging over them. Still, although it worked out for them, this is not the way to deal with appreciated assets in a C corporation. On the same day the Tax Court let the sword drop on Ray Feldman who had been involved in a similar deal with Midcoast.
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