Originally Published on forbes.com on March 7th, 2012
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Sometimes the word is slow getting out. You used to be able to sell the assets of a corporation without recognizing gain if you liquidated within one year. It was called a 337 liquidation. Seems like only yesterday, but it is one of those things that was done in by the Tax Reform Act of 1986. At Joseph B. Cohan and Associates, we evaluated every corporation and had to explain why it was not making an S election. I oversaw the process and had to deal with a bit of stubbornness here and there. Since then I have always held that you needed a reason, a pretty good reason, to operate a closely held business as a C corporation.
Apparently this reaction to the Tax Reform Act of 1986 was not universal. A couple of companies called Fortrend and Midcoast were able to make this failure to adapt to the new regime part of their business plan. After your corporation sold its assets and was just sitting there with a pile of cash, but before the year end of the sales transaction, one of them or an affiliated company would buy the stock in your corporation. They would pay you less than the pile of cash, but more than the pile less the coproate tax from the asset sale. You more or less had an inkling that they were not going to pay the same amount of corporate tax that you were, but that was neither your business nor your problem. Or so you thought.
It should come as no shock that the IRS has a way of making that corporate tax your problem. It is called transferee liability. Thanks to a Fortrend/Midcoast transaction James and Norma Slone were in Tax Court recently. The IRS was looking for something north of $15,000,000. It related to taxes incurred by Slone Broadcasting, which was renamed Arizona Media, from the 2001 sale of its assets to Citadel for $45,000,000 (The name change was so that Mr. Slone could use “Slone Broadcasting” in future ventures.)
The description of the original sale has an interesting feature:
The ensuing negotiations with Citadel were handled by a media broker consultant hired by Slone Broadcasting. Mr. Slone’s accountant, D. Jack Roberts, a certified public accountant with over 30 years of experience, advised on the accounting aspects of the transaction, and Tom Chandler, Slone Broadcasting’s attorney, advised on the legal aspects of the transaction. None of the advisers proposed tax strategies to reduce the Federal and State income taxes resulting from the sale.
Come on guys. A $45,000,000 sale of corporate assets and you can’t even come up with some bad ideas. Then, out of the blue, comes some help:
Helen Johnson, a representative of Fortrend International, LLC (Fortrend), sent an unsolicited letter and brochure to Mr. Roberts (the CPA) on June 29, 2001. Ms. Johnson’s letter described Fortrend as a “private investment/merchant-banking group” seeking opportunities to acquire corporations in situations where the “assets of the Target Corporation can be profitably sold and/or leased to one or more purchasers/lessees.” The letter also stated that Fortrend was able to “structure transactions that help manage or resolve liabilities at the corporate level.” Mr. Roberts did not review the letter and company brochure until after the closing of the asset sale.
On September 7, 2001, Ms. Johnson sent a third letter to Mr. Roberts, attaching the Fortrend/MidCoast business plan together with financial projections.
Mr. Roberts hired Steven Phillips, a local tax attorney, as counsel to advise Mr. and Mrs. Slone and the Slone Revocable Trust on any Fortrend proposals. Mr. Phillips was not involved in and did not provide any legal advice with respect to the asset sale. On September 10, 2001, Mr. Phillips met with Mr. Slone to discuss the proposed transaction. This meeting was Mr. Slone’s only contact with Mr. Phillips. Mr. Roberts represented Mr. Slone in all other communications with Mr. Phillips.
Mr. Roberts and Mr. Phillips knew that Fortrend had a strategy to reduce the income tax due as a result of the asset sale. When they asked Fortrend what actions Berlinetta would take to achieve the tax savings, they were told that Fortrend’s methods could not be disclosed because they were “proprietary”. However, Fortrend represented that Berlinetta had not engaged in any transaction that would be deemed a “listed transaction” pursuant to Notice 2001-51, 2001-2 C.B. 190. Mr. Phillips negotiated an increase in the purchase price for the stock based upon what he described as a “premium” payment resulting from the tax savings anticipated by Berlinetta. When negotiations concluded, the parties agreed to a purchase price of $35,753,000 plus Berlinetta’s assumption of Slone Broadcasting’s Federal and State income taxes owed as of the closing date.
The plan to reduce corporate income taxes did not actually work, but by the time the audit was concluded, Arizona Media had no assets. So the IRS pursued the sellers. The Tax Court found in favor of the taxpayers citing a number of reasons:
The plan to reduce corporate income taxes did not actually work, but by the time the audit was concluded, Arizona Media had no assets. So the IRS pursued the sellers. The Tax Court found in favor of the taxpayers citing a number of reasons:
We will respect the form of the transactions in this case. Respondent has conceded that the asset sale was independent from the stock sale. …..Mr. Roberts credibly testified that no tax strategies to offset the potential gain arising from the asset sale were discussed before the closing of the asset sale. The asset sale closed on July 2, 2001, more than five months before the closing of the stock sale. Slone Broadcasting’s first installment of $3,100,000 of Federal income tax attributable to the asset sale was paid. There is no evidence that Fortrend, Midcoast, or Berlinetta was involved in any way in the asset sale, nor is there any evidence that a sale of stock was anticipated at the time that the asset sale was negotiated and closed.
The purchaser of the stock, Berlinetta, was capable of closing by using funds provided by loans from Rabobank and other assets it owned. Berlinetta agreed that it would not use the assets of Slone Broadcasting for 10 days after the closing of the stock sale.
When Mr. Roberts and Mr. Phillips asked Fortrend for more information about how Berlinetta planned to offset the gains from the asset sale, they were told that Fortrend’s methods were “proprietary”. Petitioners didnot have a duty to inquire further and are not responsible for any tax strategies Berlinetta used after the closing of the stock sale.
The Tax Court noted that there have been several other Fortrend/Midcoast transferee liability cases. I’ve written about two of them, the Frank Sawyer Trust and Feldman. Feldman was one of the two cases where the taxpayers were nailed with the transferee liability. Viewed cynically, it seems like Feldman was a lower dollar deal and did not rate the A Team, so it was poorly executed. It appears that Midcoast did not have help from Fortrend in excuting the Feldman transaction. Even though, most of the taxpayers that the IRS chased due to Fortrend/Midcoast deals ultimately prevailed, they still had to take a haircut on the original deal and the stress of the litigation must have been intense. Which brings us to the moral of the story. If you have appreciated assets in a C corporation and you think you may sell someday, start planning now. With sufficient lead time there are many ways to legitimately avoid double taxation.
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