"’UNIFIED BUSINESS ENTERPRISE” THEORY

Under Code §183, individuals and S corporations desiring deductions for their business activities must be engaged in the activity “for profit.” Activities which consistently generate losses may be presumed to be not for profit.

A recent case illustrates a seldom-discussed theory or concept, known as the “unified business enterprise” theory. Under this theory, a taxpayer conducting activities in isolation which generate losses and thus may be considered not to be “for profit” under Code §183, may be able to aggregate that activity with other activities conducted either individually or through other commonly controlled entities to come up with a profit motive for an aggregate, or “unified business” enterprise that will avoid the limits of Code §183.

The cases tend to arise where property, such as an airplane or land, is owned and leased to a related business venture, with losses arising in the owning entity.  In the current case, the taxpayer was a principal in the Hard Rock Café chain. The taxpayer owned several aircraft in one or more entities, which aircraft were used by the taxpayer and/or other entities. The IRS asserted that deductions relating to the aircraft should be disallowed because the owning entities were not operated for profit. The taxpayer countered with the unified business enterprise theory.

The Court of Claims sustained the application of the unified business enterprise theory to the taxpayer’s situation, and ruled against the IRS (although IRS issues of substantiation of expenses were allowed to go forward). The IRS raised the cases of Deputy v. du Pont, 308 U.S. 488 (1940) and Moline Properties, Inc. v. Comm., 319 U.S. 436 (1943) to show that corporations and their shareholders should be treated as separate and distinct for tax purposes.  However, the court noted that in those older cases, S corporations were not involved, and did not involve overlapping businesses that essentially treated the S corporations as alter-egos for the taxpayer owner.

Thus, the unified business enterprise theory is alive and well, at least for pass-through entity situations such as S corporation and partnerships. Situations involving C corporations should expect greater resistance, if not outright rejection, of the theory by the IRS and courts.

Morton v. U.S., 107 AFTGR 2d 2011-xxxx (Ct Fed Cl), April 27, 2011

WHERE IS MY REFUND?

If you have an iPhone or an iPad, there is a new way to check on when to expect your income tax refund. By using the IRS2Go app, you can get this information on i-device. The app is available at the Apple app store.

Haven’t tried it myself, so I can’t vouch for its accuracy or effectiveness.

SECTION 332 LIQUIDATION OF INSOLVENT SUBSIDIARY VIA CONVERSION TO DISREGARDED ENTITY

A corporation converted its wholly owned subsidiary to a disregarded entity via a check-the-box election. At the time, the subsidiary was insolvent. The parent corporation sought a worthless stock loss under Code §165(g)(1).

At issue is Code §332 which will not allow a parent corporation shareholder to recognize gain or loss on liquidating distributions of an 80%-or-more owned subsidiary. The corporation sought a private letter ruling to the effect that Code §332 did not apply.

A necessary requirement for Code §332 to apply is that the parent must receive at least partial payment for the stock it owns. Since a check-the-box election to be treated as a disregarded entity treats the electing corporation as liquidating, at least in normal circumstances it would appear that this constructive liquidation would result in the requisite partial payment for the stock and Code §332 would apply to disallow the loss.

However, in this case the subsidiary was insolvent. The taxpayer sought to apply Rev.Rul. 2003-125 in context of this constructive liquidation. In that Ruling, the  IRS concluded that when the fair market value of the subsidiary's assets, including intangible assets such as goodwill and going concern value, is less than the sum of the subsidiary's liabilities, including bona fide liabilities owed to the parent, no part of the transfer is attributable to the parent's stock ownership and the above payment -for-stock requirement isn't satisfied. Accordingly, the Code Sec. 332 nonrecognition rules didn’t apply.

On a constructive liquidation of an insolvent subsidiary, the same effect should occur, even though no physical movement of assets occurs. Thus, in theory, Rev.Rul. 2003-125 should apply.

Theory does not always apply when dealing with the IRS. However, in this situation, it did, and the IRS acknowledged that Rev.Rul. 3002-125 could apply to a constructive liquidation under a check-the-box election. Thus, the parent corporation obtained the worthless stock deduction.

As an aside, note that the parent corporation was able to receive an ordinary loss instead of a capital loss, by reason of the application of the affiliation exception under Code §165(g)(3).

PLR 201115001