Even A Little Substance Matters

In Uncategorized on 05/19/2011 at 16:58

Sorting through much financial maneuvering, the details of which I’ll spare you,  Judge Marvel gives us a roadmap to business activities that permit a controlled entity to be considered a separate entity for tax purposes, even when there is no substantial business purpose, in Weekend Warrior Trailers, Inc., T.C. Mem 2011-105, released 5/19/11.

Weekend Warrior (“WW”) created a management services C Corp called Leading Edge (“LE”). IRS contended LE was formed with no legitimate business purpose or economic substance, and should be disregarded as a sham. 2011 T.C. Mem. 105, at p. 44.

Tax Court rejects IRS’ position, and expressly denies that it reaches its conclusion on Section 482 grounds.

Citing Moline Props., Inc. v. Commissioner, 319 U.S. 436 (1943), at pp. 438-439, Tax Court states: “Whether the purpose be to gain an advantage under the law of the state of incorporation or to avoid or to comply with the demands of creditors or to serve the creator’s personal or undisclosed convenience, so long as that purpose is the equivalent of business activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity. [Fn. refs. omitted.]”. 2011 T.C. Mem. 105, at p.45.

Now for the kicker. Moline sets out alternative methods of deciding the validity of a controlled entity. Substantial business purpose is one, and business activity is another; either will do to save the controlled entity. But how do you (or more to the point, how does Tax Court) define an “equivalent of a business activity”, absent a valid business purpose (and Tax Court found none here)?

Judge Marvel tells us, at least based on the facts of this case: “Even if a corporation was not formed for a valid business purpose, it nevertheless must be respected for tax purposes if it actually engaged in business activity. . . .

“Leading Edge provided personnel services to Weekend Warrior. It maintained an investment account and bank accounts. It paid its employees by check, adopted a retirement plan, which respondent does not timely argue was a sham, kept books and records, and engaged Mr. . . . to appraise its stock. Leading Edge invested excess funds and at least from August 2003 through December 2004 purchased and sold stocks and received dividends. Corporate formalities were followed. Leading Edge filed Federal income tax and employment tax returns. We conclude Leading Edge carried on sufficient business activity to be recognized for Federal income tax purposes. 2011 T.C. Mem 105, at pp.48-49.

So bank accounts and corporate books by themselves aren’t enough, it seems. The personnel services and employment tax filings, together with the financial activities, over a 15-month period, seem to save LE.

The takeaway? Even a little substance matters.

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