In Uncategorized on 10/30/2013 at 22:17

 The old tennis player’s truism proves true for John D. Moore and Julia A. Smith, f.k.a. Julia A. Moore, in 2013 T.C. Memo. 249, filed 10/30/13.

John started as a humble CPA, but kept on truckin’, until he worked his way up to be president of Peterbilt. Anyone who’s ever driven an Interstate knows what a Peterbilt is. As reward for John’s loyal service, he got to buy 5% of the family Sub S for $241K, which he paid for.

Later on, Peterbilt merged with another outfit, in the course of which Peterbilt granted stock to the stockholders of the mergee. When the mergee stockholders wanted to sell their Peterbilt stock, the family wanted the stock in safe hands. Whom else but trusty John should hold the family jewels?

So Peterbilt lent John the $5 million against his promissory note, on which he was personally liable. They tinkered with the terms after the loan and stock purchase, but John remained on the hook.

Two years down the road, John having paid Peterbilt zippo, John sues Peterbilt, claiming mutual mistake as to the value of the stock he bought, if he knew the facts he never would have paid $5 million for stock worth $1 million, etc.

They settle, and John gets off the hook for all but $1 million. On top of which, John’s brilliant accountant, Catherine Fox from BDO, gets John off the COD (cancellation of debt) hook by claiming good faith dispute (see my blogpost “Blogger’s Holiday”, 7/4/13). IRS buys it.

Fast forward three years. John unloads his stock for $3 million and claims a $1.5 million capital loss, resulting from his alleged $5 million basis. Catherine dreamed that one up, and I give her a Taishoff “good try”; basis consisting of relieved debt plus real cash really is creative.

Unfortunately for Catherine and John, Ch J Thornton isn’t buying it. To compute gain on sale of a capital asset, start with cost. As this is Sub S stock, Section 1367 adjustments must be made, but we’ll skip that for now, as Ch J Thornton does. IRS claims $1 million, because that’s what the stip settling John’s lawsuit said.

“Although cost basis generally equals the price paid for property, irrespective of its actual value, this rule might not apply ‘where a transaction is based upon “peculiar circumstances” which influence the purchaser to agree to a price in excess of the property’s fair market value.’” 2013 T. C. Memo. 249, at p. 10 (Citation omitted).

John and Catherine claim that the loan was a separate transaction from the stock purchase, but this goes nowhere. John claimed in his lawsuit that he bought the stock with money Peterbilt lent to him. The money was paid directly to the selling stockholder, and John couldn’t have done anything with the money.

It was as if Peterbilt bought the stock and sold it to John. Thus, when John and Peterbilt settled their lawsuit, it was as if Peterbilt gave John a reduction in the purchase price of the stock. Anyway, it was not an arms’-length deal, and Peterbilt never expected to be paid $5 million.

“Petitioners also point to the fact that the IRS’ examination of their 2002 tax return resulted in a determination that the agreed judgment did not give rise to cancellation of indebtedness income for them because the amount of the debt was in dispute. This circumstance, however, supports rather than undermines our conclusions. The determination that petitioners had no cancellation of indebtedness income for 2002 is consistent with our view that Mr. Moore’s original debt… was not absolute and that the actual amount of the debt was the $1 million ultimately reflected in the agreed judgment. To permit petitioners a basis in the … stock reflecting the nominal purchase price of the stock… without realizing any cancellation of indebtedness income as a result of the agreed judgment would result in an unjustified tax windfall to petitioners.” 2013 T. C. Memo. 249, at pp. 21-22 (Names omitted).

But John did buy $241K of basis in the 5% of the stock he bought before the shenanigans started, and IRS didn’t give him that, so Ch J Thornton does.

You want basis, you have to buy it. Earn your way to the net.

And John’s reliance on Catherine gets him off the hook for penalties, although I suggest re-reading my blogpost “OPIS Finis”, 1/18/12. While Catherine and BDO weren’t promoters of the deal, it certainly sounds too good to be true, and John was a CPA and president of a heavy-duty corporation, a savvy businessman.

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