Originally published on Forbes.com June 13th, 2014
The IRS does not like the concept of “personal goodwill”, but courts have often approved it. In the Tax Court decision in the case of Bross Trucking, the concept was confirmed again, helping to save the taxpayer from what appears to me to be a real overreach on the part of the IRS. Here is the story.
Chester Bross started in the road construction business in 1966. Chester Bross Construction Company counts among its clients the highway departments of Missouri, Illinois and Arkansas.
Mr. Bross was extremely knowledgeable about the industry and contributed to nearly all facets of the Bross family businesses. He learned about the road construction industry by “just at it” to gain experience. As the patriarch of the family and its businesses, he was responsible for arranging and completing the projects in which Bross Construction participated. He personally developed relationships with the necessary entities to work in the road construction industry. Further, Mr. Bross was responsible for fostering and maintaining relationships under the Bross family business umbrella to ensure that projects were successfully completed.
The “family business umbrella” included Bross Trucking which was founded in 1982 and owned 100% by Mr. Bross through his revocable living trust. Bross Trucking engaged in hauling construction-related materials and equipment for road construction projects. Bross Trucking would also haul coal in the winter for other customers. However, Bross Trucking owned very little trucking equipment. Instead, Bross Trucking leased most of its equipment from another wholly owned Bross entity, CB Equipment, through yearly leases.
According to the Tax Court decision, Bross Trucking had some regulatory problems – issues around maintaining records on drivers and safety. Mr. Bross came to believe that the company’s reputation with regulatory authorities was causing its trucks to be stopped more often. If the problem cascaded, it could disrupt other aspects of the family business, since the road construction relied on the hauling provided by the trucking company.
The solution was to form LWK Trucking which was owned by Mr. Bross’s three sons and a minority shareholder. There was some fancy tax planning as Roth IRAs were used to own some of the stock. Overall, though, it seems that the goal was to have a trucking company that had a regulatory fresh start. Bross Trucking continued to exist but no longer operated. No assets were transferred from Bross Trucking to LWK, although that is not how the IRS looked at it.
The IRS view was that Bross Trucking had distributed its goodwill to Mr. Bross who then made a gift of the goodwill to his sons. With penalties the IRS was looking for over $2.7 million in corporate income tax and gift tax.
The Tax Court cited one of my favorite cases – Martin Ice Cream
In Martin Ice Cream Co., an ice cream company distributed products (including Haagen-Dazs) to both supermarkets and small stores. Its controlling shareholder personally developed valuable relationships with the supermarkets, and the corporation spun off its supermarket distribution rights to a subsidiary wholly owned by that controlling shareholder, who then transferred them to Haagen-Dazs along with the subsidiary’s business records, customer records, and associated goodwill. The shareholder signed a consulting agreement and a noncompete agreement with Haagen-Dazs. The Commissioner argued that the ice cream company should be taxed on the gain from the sale of the subsidiary; however, the Court held that the customer relationships and distribution rights were the shareholder’s personal assets and not company assets.
I Scream For Ice Cream
How can you not love a decision that is so taxpayer-friendly, that has “ice cream” in its name? The Tax Court followed the Martin Ice Cream logic
…….. there are two regimes of goodwill: (1) personal goodwill developed and owned by shareholders; and (2) corporate goodwill developed and owned by the company. Bross Trucking’s goodwill was primarily owned by Mr. Bross personally, and the company could not transfer any corporate goodwill to Mr. Bross in tax year 2004.
The other reason that the case was an overreach on the part of the service is that it really hard to argue that a company facing the possibility of being shut down has much in the way of goodwill.
The impending suspension would cause customers to reevaluate whether to trust Bross Trucking and continue to do business with it. Indeed, Mr. Bross expressed his concern to his attorney that Bross Trucking might not be able to perform necessary functions as a result of the suspension. Mr. Bross’s solution was to find or create another business to take over the trucking needs for the Bross family businesses. This is the antithesis of goodwill: Bross Trucking could not expect continued patronage because its customers did not trust it and did not want to continue doing business with it.
Did Bross Catch The Agent From Hell?
It has only happened to me a couple of times, but there is a phenomenon that I have labeled the agent from Hell. AFH might not be technically strong but he or she has an instinctive sense that anybody with an enterprise with more than a few moving parts must be up to something. A stopped clock being right twice a day, AFH in his or her long career has probably uncovered more than a few sketchy schemes that would have gotten by less dogged agents. When AFH hits somebody without anything exciting going on, he or she just does not know when to quit.
The other observation I have in this case is that it is pretty unusual to have a corporate income tax case consolidated with a gift tax case. Usually, you don’t get income tax auditors raising gift tax issues or visa versa.
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Afternote
Although Martin Ice Cream is one of my favorite cases, it is not my all time favorite. That would be Cohan v Comm, which gave rise to the “Cohan rule”. My rendering of the Cohan rule is “If you don’t have documentation, at least have a plausible” story. Many of the staff at Joseph B. Cohan and Associates thought that the rule had been named for the eponymous founder or his son Herb Cohan, our managing partner. Actually it was Broadway producer George M. Cohan. If you are ever in Times Square, be sure to check out his statue and if you are a tax geek, be sure to get your picture taken with it.