Ernie Ryder’s Sub S ESOPs finally get deconstructed in Pacific Management Group, BSC Leasing, Inc., Tax Matters Partner, et al., 2018 T. C. Memo. 131, filed 8/20/18, a consolidation of eleven (count ‘em, eleven) cases, all involving the water boys who put together an aquatic environment firm that ranged from water traps on golf courses to artificial lakes and waterfalls.

I’ve blogged Mr Ryder’s various maneuvers and delictions before. I’ll skip the cross-references.

Ernie’s gambit this time was stuff-the-ESOPs. The original outfit was a group of C Corps, so the principals were being double taxed. Ernie had them each form a Sub S with an ESOP, the only beneficiary of  each of which was a principal. He set up the usual ”management” and an original  “factoring” skim via a partnership of the sub Ss, which drained the profits of the C Corps, paying nominal salaries to the principals, and having the S Corps stuff the ESOPs.

The C Corp supposedly sold its receivables to a partnership of the S Corps in exchange for some “management fees” that partnership was skimming from the C Corp. Of course, the factoring partnership did none of the things a commercial factor does (pays up front at a discounted rate for the receivables, collects amounts due themselves, files UCC-1 financing statements, gets verification of services rendered and monies owed). In effect, the C Corps had to fund the factor via the “management fees”, not the other way round. I’ve represented factors, and a tougher crew would be hard to find; these guys weren’t in that league.

Ernie of course got a piece of the tax-avoidance action.

At the end of 2005, Congress ended the single-member ESOP dodge. Whereupon Ernie set up a new structure with more players, but the same dodge.

IRS was late with the NBAPs to the notice partners, but that’s not a jurisdictional defect. And even where the Sub Ss who were partners elected out of TEFRA, the sole shareholders all got SNODs, so they’re in. And since the items in question are before the court, the fact that the FPAA partnership itself is out for want of jurisdiction (no partner left) doesn’t matter.

First up, Judge Lauber blows off the C Corps’ deductions. The factoring deal totally ignored industry standards (see my comment above about professional factors).

“In a true factoring relationship, the factor supplies working capital and liquidity to the client.  Here the opposite was true:  The client provided working capital to the factor to enable the factor to do the factoring.  There is no factual basis whatever for petitioners’ assertion that the factoring arrangement ‘facilitated working capital.’  The scheme was a circular flow of funds whereby the (C Corps] supplied liquidity to themselves.” 2018 T. C. Memo. 131, at p. 46 (footnote omitted).

As for the “management fees” and bonuses paid the principals, Judge Lauber does a mix-and-match based on IRS’ expert and adding back the phony factoring money, and gives the principals more than IRS, but a lot less than Ernie’s numbers.

“The principals hired Mr. Ryder to create a tax structure that would enable them to defer taxation of substantial portions of their income, paying current tax only on income needed to defray current living expenses.  The bulk of the [C Corps’] profits was distributed through [partnership] as disguised expenses and was invested for the principals’ benefit on a tax-free basis.  It is clear that the funds extracted from the [C Corps’] in this way ‘create[d] “economic gain, benefit, or income to the owner-taxpayer[s].’”” 2018 T. C. Memo. 131, at pp. 67-68. (Citation omitted).  Thus constructive C Corp dividends to the principals, which Judge Lauber apportions as best he can “scientific accuracy” being impossible.