This is an idea for an article from the following source:
http://www.forbes.com/sites/peterjreilly/2012/01/04/boston-taxi-heirs-prevail-in-tax-court/
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.
BrianLovett and Tony Nitti, who also wrote about this case, titled their postIgnorance 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 Feldmanwho had been involved in a similar deal with Midcoast.
It looked like the Sawyer family, heirs to a taxi fortune, had beaten the IRS on a major tax exposure at the end of 2011. Sadly, the First Circuit has told the Tax Court to take another look and possibly rain on their parade. The taxes involved were from 2000, but it is a reasonable speculation that moves neglected in 1987 were the real source of the problem. The problem was significantly appreciated property inside four C corporations. Corporations owned by the Sawyer Family Trust were the largest owners of Boston taxi medallions. Originally issued for $50 in the 1930s, they were each worth hundreds of thousands. There was also some real estate
Could The Sawyer Family Have Avoided The Whole Problem ?
Comprehensive tax reform seems to be in the wind again. My money is on it happening after the next Congressional election. The Internal Revenue Code of 2015 ? Who knows maybe they will come up with a totally new name. The last time, they made it the Internal Revenue Code of 1986. One of the biggest changes was the repeal of the General Utilities doctrine. Under that rule, a C corporation could sell all its assets without recognizing corporate level gain pursuant to a plan of liquidation. As a back-up S corporations that were converted from C were subject to built-in gains tax for ten years after the election, but an election in 1986 avoided that problem.
The process we went through at Joseph B. Cohan and Associates was to look at every C corporation and see if there was any case for it remaining one. There were a variety of good reasons, such as net operating loss carryovers, but there were quite a few lame ones. What the reasoning of the Sawyers was is something, I’m sure I will never learn. Mr. Sawyer was barely over 90 at that point, why think about selling ?
The Problem
Ultimately there was a sale. Mr. Sawyer 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. Much of the money was raised by selling assets both the taxi medallions and some real estate. The problem is that since the assets were in C corporations there was a corporate level tax on their sale.
Fortrend To The Rescue – Kind Of
The Sawyers were far from being the only people who had missed out on 1987 S elections. There were enough that at least one company was able to make a business out of “helping” them. After your C corporation had sold all its assets and had only cash, but before the end of the fiscal year of the sale, Fortrend would buy all the stock of the company for less than the amount of cash, but more than the amount of cash that would be left after corporate taxes were paid on the gain. Obviously, they had figured out a way around the corporate tax. That would not be the problem of the seller. Or would it ?
Transferee Liability
Fortrend’s method for avoiding the corporate tax did not stand up under audit. Of course, by then the cash had been stripped out of the shell companies. The chain of events was rather complicated, you can read the original case here, if you want the fine detail. As the IRS saw it, the corporate cash that should have gone to pay taxes had been used in part to pay the sellers, thereby making the sellers liable for the corporate taxes.
The Sawyers were not alone in being pursued on this type of deal. At least in the initial Tax Court decision, they did better than most. I think it was mainly due the large stakes involved – over 20 million. The “i”s were dotted and the “t”s crossed. There was a bank loan arranged to pay the trust for the stock. It was rather a transitory loan, but there was no way that the Sawyers would have known that or, in principle, had reason to care. Tony Nitti titled his post on the case Ignorance Is Bliss.
Not So Fast
The First Circuit has suggested to the Tax Court that they need to look at whether the transfer was a “fraudulent transfer”. It is a fairly complex and lawyerly argument:
If the Tax Court does find that the $32.4 million in cash that Three Wood gave to the Trust was not reasonably equivalent to the companies whose combined book value was $25.3 million, then the next question under the Uniform Act and Massachusetts law is whether, at the time of its transfers to the Trust, Three Wood either (I) was engaged or about to engage in a transaction for which its remaining assets were “unreasonably small,” or (ii) intended to incur, or reasonably should have believed that it would incur, debts beyond its ability to pay as they became due.
I’m not really sure who I am rooting for on this one. The Sawyers may have had a perfectly legitimate means for avoiding the whole problem with just a bit of forethought. On the other hand other taxpayers who were “helped” by Fortrend ended up being held responsible because their deals had not been as well executed. We’ll have to see what the Tax Court says when it gets this back.
Making the Big Small - Estate Planning Nirvana