In Uncategorized on 06/06/2012 at 18:44

Or, If You Do It Right, You Can Do It Among Yourselves

That’s the takeaway from James Maguire and Joy Maguire, 2012 T.C. Memo. 160, filed 6/6/12.  Judge Ruwe is in the driver’s seat in this tale of two S Corps, one that sells used cars and the other that provides financing for those sales. Both the S Corps are owned by the Famiglia Maguire, hence these tears, as IRS claims the Famiglia’s mix-and-match with accounts receivable from one S Corp to the other to build basis for loss deductions didn’t really happen.

Oh no, says Judge Ruwe, the swap was real. “Held: Shareholders in two related S corporations are not prohibited from receiving a distribution of assets from one of their S corporations and then contributing those assets into another of their S corporations in order to increase their bases in the latter. The effect is to decrease the shareholders’ bases in the S corporation making the distribution and thereby reducing the shareholders’ ability to get future tax-free distributions from the distributing S corporation, while increasing the shareholders’ bases in the S corporation to which the contributions are made. The fact that the two S corporations have a synergistic business relationship and are owned by the same shareholders does not preclude accomplishing Ps’ goal, so long as the underlying distributions and contributions actually occurred.” 2012 T. C. Memo. 160, at p. 2.

Ya gotta like a Judge who makes it easy for the poor blogger.

The story:  Auto Acceptance (AA) sold cars, CNAC, Inc., financed the sales. CNAC made money, AA lost money. The Famiglia owned 100% of the stock of both, but their basis in AA was insufficient for them to take all the AA losses, as S Corp pass-through losses are limited to stock basis plus debt basis.

The Famiglia called their accountants, who told them to write a check from CNAC, where they had plenty of basis, to themselves and from themselves to AA, to increase their AA basis so they could take the losses. The Famiglia replied that the accountants could write their own checks, as the Famiglia didn’t have that much cash in the CNAC accounts.

Nothing daunted, the accountants (into whose professional credentials Judge Ruwe goes in some detail, for good-faith reliance purposes) suggest distributing to the Famiglia some receivables AA owed CNAC, whereupon the Famiglia would  transfer those to AA, and build basis thereby.

The Famiglia’s basis in CNAC was always positive after the distribution of the AA receivables to themselves and the contribution thereof to AA.

The Famiglia and the accountants papered the deals well, with corporate resolutions, adjusting journal entries, assignments, promissory notes for intraFamiglia borrowings, and took the AA losses.

IRS drops the SNODs, saying it was all a game of put-and-take.

Judge Ruwe: “In determining whether a particular transaction qualifies as a shareholder investment, a taxpayer must make an actual ‘economic outlay.’ A taxpayer makes an ‘economic outlay’ when he incurs a cost or is left poorer in a material sense after the transaction.” 2012 T. C. Memo. 160, at pp. 11-12 (Citations omitted).

IRS says there wasn’t any real economic outlay, but Judge Ruwe isn’t buying that. The Famiglia did transfer the receivables, in that there were adjusting journal entries on the respective corporate books, and there were resolutions, for each tax year at issue, timely made.

“When petitioners received the accounts receivable from CNAC, as they had every right to do, and contributed them to Auto Acceptance, that transaction reduced the liabilities of Auto Acceptance; made Auto Acceptance solvent in terms of its assets exceeding its liabilities; and increased the net worth of Auto Acceptance, exposing a greater amount of its assets to its general creditors. At the same time, petitioners’ bases in CNAC were reduced by the amounts of the accounts receivable that CNAC had distributed to them, thereby reducing their ability to receive future tax-free distributions from CNAC.” 2012 T. C. Memo. 160, at pp. 14-15 (Footnote omitted).

But the footnote says a lot: “Petitioners stress that the risk involved in exposing more of Auto Acceptance’s assets to its creditors was more than hypothetical, because by mid-2004 the Kentucky attorney general had instituted a lawsuit against petitioners and their businesses claiming millions of dollars on the basis of consumer fraud claims. Petitioners contend that the risk of the loss to Auto Acceptance’s creditors, including vendors that it alone dealt with, when viewed in consideration of the attorney general’s lawsuit, was very real and the additional net worth in Auto Acceptance created by the capital contribution was put at greater risk, making them poorer in a material sense.” 2012 T. C. Memo. 160, at p. 15, footnote 7.

Likewise the distribution from CNAC wasn’t taxable to the Famiglia under Section 1368(b), as the Famiglia still had basis in their CNAC stock after each distribution.

The Law of Relativity doesn’t torpedo the Famiglia either: “The fact that the CNAC accounts receivable were distributed to petitioners and then contributed to a related entity does not require a finding that there was no economic outlay. We have previously considered this issue and have held that ‘the fact that funds lent to an S corporation originate with another entity owned or controlled by the shareholder of the S corporation does not preclude a finding that the loan to the S corporation constitutes an “actual economic outlay” by the shareholder.’ The fact that petitioners contributed intangible assets to Auto Acceptance, rather than cash, does not preclude increases in their bases. The tax basis of an S corporation may be increased through the contribution of cash, tangible assets, or intangible assets (such as accounts receivable).” 2012 T. C. Mem. 160, at p. 16.

Or to put it simply, “(T)he fact that the two S corporations have a synergistic business relationship and are owned by the same shareholders should make no difference so long as the underlying distributions and contributions actually occurred.” 2012 T. C. Memo. 160, at p. 16.

Make it real, and you’ve got the losses.


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