Originally published on Forbes.com April 21st, 2014
The tax travails of the Sawyer family may have finally come to an end with the recent decision of the Tax Court in the case of the Frank Sawyer Trust of May 1992. It’s one of those stories about how to make a small fortune. You start with a large fortune in appreciated assets in a C corporation that is owned by a taxable estate. Sell the assets to raise cash to pay the estate taxes and use a sketchy scheme to try to avoid the corporate tax.
Frank Sawyer was a real rags to riches story. He had 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.) 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 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.
It turned out that Fortrend’s strategy for avoiding corporate income tax, did not really work, but by the time the IRS caught up with them all the cash had been stripped from the Sawyer corporations. The IRS asserted transferee liability against the Sawyer trust, saying in essence that the Sawyers got the money that should have paid the corporate tax. The Sawyer Trust argued that they didn’t get anything from the corporations. The Trust sold its stock and that was the end of it as far as they were concerned.
On the first round in Tax Court, the Sawyer Trust won. The IRS appealed and the First Circuit sent the case back to the Tax Court for a closer look. The whole analysis is rather lawyerly. In the end, the Sawyer Trust is not responsible for the entire corporate tax that Fortrend dodged, but it does have to give back the premium it received over the net asset value of the companies it sold (Cash on hand less correct corporate tax). The IRS had wanted to get nearly $20 million in corporate tax from the Trust. The decision limits the recovery to $13.5 million, before interest and penalties. It is still quite painful when you consider that an S election in 1987 would have legitimately avoided the entire problem.
In sum, the Trust received fraudulent transfers from the Fortrend acquisition vehicles and, accordingly, is liable as a transferee of a transferee. We now turn to the amount of the Trust’s liability. Liability Amount The IRS issued notices of liability to the Trust, stating that it owed $11,822,600 and $8,483,997 in Federal tax for the taxi and real estate corporations, respectively. However, the parties have stipulated that the acquisition vehicles overpaid book value by only $7,145,047 and $6,350,023, respectively. The amounts in the notices of liability substantially exceed the excess value the Trust received for the corporations. Under Massachusetts law, a good-faith transferee is entitled to a judgment liability reduction to the extent of the value it gave the debtor for the transfer. See Mass. Ann. Laws ch. 109A, sec. 9(d).
As we stated in Frank Sawyer II, we are convinced that the Trust lacked actual or constructive knowledge of the postclosing activities Fortrend had planned. Consistent with that holding, we believe the Trust acted in good faith. Accordingly, Massachusetts law limits respondent’s recovery to $13,495,070, the amount the Trust received in excess of the corporations’ fair value
Jack Townsend did an analysis of the First Circuit appeal and planned to write something on the final decision when last I heard from him.
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