In Uncategorized on 07/02/2015 at 16:38

It’s not a parlor game for Qinetiq U.S. Holdings, Inc. & Subsidiaries, as they lose a heavy-duty salary-and-wages deduction but gain a $13 million deficiency thereby, in 2015 T. C. Memo. 123, filed 7/2/15.

The case is also notable for Judge Goeke’s retirement from the partitive genitive war, as he apparently has abandoned his former alliance with Judge Mark V. Holmes; see my blogpost “Tax Court’s War on the Partitive Genitive,” 1/3/14, where Judge Goeke, dealing with the same case, enlisted in that war.

Back to taxes. Qineteq bought out a sub S started by two consultants. The outfit started with Consultant 1 and spouse, but spouse dropped out in favor of Consultant 2, and Consultants 1 and 2 renamed the sub S. The Consultants threw $1000 into a bank account and got all the stock in the renamed sub S.

Throughout the subsequent sub S’s career, the Consultants took distributions from the sub S but paid no SE. Though the stock was restricted, they never transferred any, or entered into employment agreements with the sub S.

They did have employment agreements with employees, to whom they issued restricted non-voting stock. This ordinarily would have torpedoed the S election, but Consultants got a Section 1362(f) whoops PLR, which put them back on the straight-and-narrow.

Qineteq buys out the Consultants for $123 million. Qineteq claims the stock was issued for continuous services, was subject to substantial forfeiture, and therefore was payment for services per Section 83. Thus ordinary income to Consultants and deductible by Qineteq.

No, says IRS, capital gains to Consultants, no substantial risk of forfeiture, and no deduction to Qineteq.

Judge Goeke: “We acknowledge there are cases suggesting that a broad reading of the applicability of section 83 is appropriate. See, e.g., Alves v. Commissioner, 79 T.C. at 876 (‘Congress * * * has clearly expressed the intention that section 83 is to have the broadest application’); Montelepre Systemed, Inc. v. Commissioner, T.C. Memo. 1991-46, 1991 Tax Ct. Memo LEXIS 65, at *19 (‘[T]he statute only envisions some sort of relationship between the services performed and the property transferred.’). However, on the facts and circumstances of this case, we conclude that petitioner has failed to prove the … stock was transferred in connection with the performance of services pursuant to section 83. Nonetheless, in this matter we believe the crux of our section 83 analysis is whether the… stock was subject to a substantial risk of forfeiture.” 2015 T. C. Memo. 123, at pp. 23-24.

It’s OK if you were somehow working there when you got the stock; but were you at serious risk of losing the stock?

There’s a five-way test for holders of substantial portions of voting stock, and Consultants 1 and 2 certainly did.

“Those factors are: (i) the employee’s relationship to other stockholders and the extent of their control, potential control and possible loss of control of the corporation; (ii) the employee’s position in the corporation and the extent to which he is subordinate to other employees; (iii) the employee’s relationship to the officers and directors of the corporation; (iv) the person who must approve the employee’s discharge; and (v) the employer’s prior actions in enforcing the provisions of the restrictions.” 2015 T. C. Memo. 123, at p. 25.

Nobody but the Consultants ran the shop, and their class of stock was only issued to them and no one else. Their stock was never transferred. But the decision seems to go off on the fact that the sub S ran very well, and neither Consultant wanted to oust the other.

And the Consultants stipulated that they always told the same story for tax purposes. They did; they never said they were getting stock for services, and whatever they got was dividends and not salary and wages.

I see an appeal coming. It’s not so clear-cut as Judge Goeke makes it out. We’ve all seen partners who really got on a treat taking up the battleaxes and using every move in the book when things turn sour. And that forfeiture never happened before doesn’t mean it’s so remote as to be negligible.

Stay tuned.


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