Accounting Today visitors: click here for the item from the September 17 “In the Blogs.”
When tax-free merger isn’t. Working with family-owned businesses, a common misunderstanding arises: if a deal is tax-free, like an “A” merger or a partnership contribution, there can’t be gift tax, right? Very wrong, as a New Hampshire couple’s experience in Tax Court shows.
The parents, Mr. and Mrs Cavallero, had a successful S corporation known as Knight Tool Co. Their son Ken set up another business to make liquid dispensing machines, Camelot. As part of their estate planning, the two companies merged in an income tax-free deal. From the Tax Court summary:
Ps and their sons merged Knight and Camelot in 1995, and Camelot was the surviving entity. Valuing the two companies in accordance with the advice their professionals had given, Ps accepted a disproportionately low number of shares in the new company and their sons received a disproportionately high number of shares.
It turns out that the estate planners “postulated” a technology transfer earlier in the lives of the companies that would have resulted in most of the value already being in the second generation. One planner explained to a skeptical attorney that “History does not formulate itself, the historian has to give it form without being discouraged by having to squeeze a few embarrassing facts into the suitcase by force.”
The trouble with doing that is that when the latches break, the suitcase spills all over the place. But the planners persisted. From the Tax Court decision:
As a result of Mr. Hamel’s correspondence campaign, however, the previously separate tracks of advice — one from the accountants at E&Y and Mr. McGillivray, and the other from the attorneys at Hale & Dorr — now came together for the first time. The contradiction was evident to all the professionals: The accountants had assumed no 1987 transfer (and thus believed there was a need for a means to transmit value to the next generation), but the attorneys postulated a 1987 transfer (and subsequent transfers) pursuant to which that value had already been placed in the hands of the next generation. The attorneys eventually prevailed, however, and the accountants acquiesced. Eventually all of the advisers lined up behind Mr. Hamel’s suggestion that a 1987 transfer be memorialized in the affidavits and the confirmatory bill of sale. They provided a draft of the documents, which Mrs. Cavallaro read aloud to Mr. Cavallaro. After they reported a few typographical errors, the attorneys prepared final versions, which Mr. Cavallaro and Ken Cavallaro executed on May 23, 1995.
So in 1995 they executed documents for a 1987 transaction. What could go wrong? Well, perhaps the IRS could come in and assess $27.7 million in gift taxes, plus fraud penalties. And they did. The dispute ended up in Tax Court. The IRS won the main issue — its argument that the valuable technology was not in fact transferred in 1987 — and with that win, predictably also won the battle of appraisers. The IRS appraiser at trail asserted a $29.6 million gift, which would result in a gift tax of about $14.8 million at 1995 rates. Because of the involvement of the outside experts, the Tax Court declined to uphold penalties.
This shows how important valuation can be even in a “tax-free” deal. When doing business among family members at different generations in estate planning, you don’t have the conflicting interests that unrelated buyers and sellers have, so you have the possibility of creating a taxable gift if you are careless. It’s natural for family members to believe numbers that help their estate planning, so it’s wise to get an independent appraiser in to provide a reality check. And if the facts, or values, don’t fit into the suitcase, don’t squeeze; get a bigger suitcase.
Instapundit, IRS COMMISSIONER: Our Story On The IRS Scandal Isn’t Changing. It’s Just, You Know, Evolving Now And Then. “I’ve taken a dislike to this Koskinen fellow. He seems sleazy even by DC standards.”
TaxProf, The IRS Scandal, Day 497. Mostly coverage of another slippery appearance by Commissioner Koskinen before House investigators.
Peter Reilly, Need To Show Rental Effort To Deduct Expenses. “I think the way I would put it is ‘If at first and second and third you don’t succeed, try something different. Otherwise forget about deducting losses.'”
David Brunori, Fairness and the Reality of State Tax Systems (Tax Analysts Blog) “etc. This week WalletHub released a rating of the fairest state and local tax systems… I am not doubting the accuracy of WalletHub’s survey. But the results don’t align with political reality.”
Cara Griffith, Single Sales Factor May Be Inevitable, but Is It Fair? (Tax Analysts):
In the end, if state officials are truly concerned with making their state more attractive to businesses, perhaps they should consider retaining (or returning to) the three factor apportionment method and focus on a less burdensome corporate tax system overall. In the end, if state officials are truly concerned with making their state more attractive to businesses, perhaps they should consider retaining (or returning to) the three factor apportionment method and focus on a less burdensome corporate tax system overall.
No, they are concerned with ribbon cuttings, press releases, and campaign contributions from those seeing tax credits and carveouts.
Renu Zaretsky, A Hail Mary or Two on the Hill. The TaxVox tax headline roundup covers inflation adjustments and beating up on the NFL with the tax code, among other things.
Alan Cole, Why do I have Four Different Retirement Accounts? (Tax Policy Blog) “Give us one unlimited saving account, tax it properly, like an IRA, and let us use it how we will.”
Russ Fox, Zuckermans Sentenced; No Word on Fido & Lulu “Unfortunately, members of a board of directors must be human: Fido and Lulu don’t qualify.”
Adrienne Gonzalez, Mad Scientist Gets Prison Time for Using His Dog and Cat in a Tax Avoidance Scheme (Going Concern). PETA couldn’t be reached for comment.