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Sunday, July 03, 2016

Anatomy of a Busted Tax Rescue Transaction

For many years, there were companies out there that marketed a service to tax professionals to help their corporate clients with large tax liabilities. I remember receiving solicitations to think of them if I came across companies that could benefit from their services. The bare bones of a typical transaction involved a C corporation that had sold assets for a gain or otherwise incurred a large amount of income (or expected this to happen in the near future). The rescue company would purchase the sale of the stock of the company, either with rescue company funds, funds from a lender, or possibly from the target company itself.

Stockholders would do this because they were promised more in funds than if the corporation paid the tax liability and liquidated. How? The rescue company asserted that it had companies available with large tax losses, or had other arrangements that could generate a tax loss, that the target company could use. Thus, the large tax bill to the IRS of the C corporation would never have to be paid, and the rescue company and the shareholders of the target company would split that tax savings between them.

These were the facts before the Tax Court in a recent case. The facts are pretty lengthy, but in essence the target company had a large tax liability to the IRS due to a litigation award. The rescue company arranged for the purchase of the shareholders’ stock via a loan from a third party lender, which loan was secured by and was to be repaid from the cash of the rescue company. After the acquisition, Treasury bills of low value were contributed to the target company, and the target company asserted a carryover basis in those bills of over $50M. The target company claimed a loss on the Treasury bills which eliminated the corporate income tax on the litigation award.

The IRS disallowed the loss, and turned its eye on the shareholders as transferees of corporate funds to pay the taxes.

Ultimately, the IRS won on its transferee liability claim. It did this first by finding that the transaction was a fraudulent conveyance under state law - here, Oregon. Recasting the transaction as a corporate redemption of the shareholders, the shareholders were found to be liable for the unpaid taxes of the target corporation under Oregon law.

The court then applied Section 6901 to find federal transferee liability for the shareholders, since the transaction had no practical effects other than the creation of tax losses.

An important fact was that the shareholders had been warned that the contemplated transaction could be a “listed transaction” and that there could be transferee liability for the shareholders - indeed, PriceWaterhouse Coopers refused to become involved with the transaction due to these issues. So the shareholders were forewarned there were problems with the transaction, and that assisted the court in making the appropriate findings for transferee liability under state and federal law.

I’m not sure if any of these rescue companies are still out there. If approached, taxpayers and their advisors should use extreme caution in entering into these rescue transactions.

Estate of Richard L. Marshall v. Comm., TC Memo 2016-119

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