It’s the high school garage band story all over again in this case—the band mysteriously dissolves, only to re-form an almost identical group with a different bass player. Here, three partners designed a company to help commercial establishments electronically recover funds from customers’ bank accounts after their checks bounced. Within a few months, the company had over 50 clients and licensing agreements with suppliers.
However, in nine months two of the partners decided to oust the third. Read More...
Dissenter Was Not Victim in Sale of Real Estate Holdings
Several professional tenants in a commercial office formed a C corporation to purchase the property in 1979. The owner of an accounting firm took a lead interest (26%), served on the board of directors, and provided the company’s accounting services until he retired in 1996. The company owned and operated the building as its sole asset for nearly 25 years when the directors considered converting to an S corporation, primarily to avoid double taxation (at the corporate and shareholder level). The board also discussed selling the building and dissolving the company. In 2000, the company repurchased the shares of two non-tenant owners at $42.50 per share. During the next year, it offered to repurchase the interests of all non-tenant owners, including the retired accountant, for $48.50 to $50.00 per share. Read More...
Jury Awards $10M Lost Value for Internet Start-up—Court Reverses
A Texas jury sided with the underdog and its damages expert to find that a small Internet start-up without any capital, customers, or products would have been worth $3 million, “but for” the defendant’s bad acts. Then it added $6 million in punitive damages, plus interest and penalties, for a total judgment of $10 million—this for a company that had $238.00 in its bank account the day the defendants allegedly shut it down. Read More...
Buy-Sell Agreement Value is Binding, but Valuation Must be Well Founded
Inzer v. Inzer, Inc, 2009 WL 2263818 (Tenn. Ct. App.)
Another example of a court working to marry reasonable reality with valuations can be found in Inzer v. Inzer, Inc, 2009 WL 2263818 (Tenn. Ct. App.) (July 28, 2009). In this case, a couple invests in a Sonic Drive-In, but it is the husband who becomes the “working manager-member” and 24% owner of the franchise. However, at the time of purchase, the wife signs an acknowledgement of the buy-sell provision in the Operating Agreement, which set out a specific method of calculating the redemption price for the 24% share in the franchise.
Flash forward to their divorce, seven years later, and the husband’s expert comes up with a value of $33,102, based on the buy-sell agreement, arguing that the value should be based on net book value without any consideration of goodwill or discounts. The wife’s expert valued the same interest without regard to the buy-sell agreement at $509,000. At trial, the court found that the husband’s expert valuation defied common sense, given the husband’s annual earnings of over $150,000, but the court also found that the buy-sell provision did not affect value and that a marketability discount did not apply, coming to a (seemingly random) value of $207,456. On appeal, the court reluctantly found that the buy-sell agreement bound the determination of value, but rejected the husband’s expert valuation, remanding the case for findings of value that specifically followed the terms of the buy-sell.
Discounting Minority Interests
In re Marriage of Williams, 2009 WL 2597950 (Mont.)
Here again, a husband’s actual earnings and assets are re-scrutinized by an appellate court concerned with the most “objective” result. In In re Marriage of Williams, 2009 WL 2597950 (Mont.) (Aug. 25, 2009), father and son owned equal shares in a trucking business and a real estate holding company. The son’s actual annual income prior to the divorce had been between $200,000 and $300,000, but the court reduced it to $100,000, on the theory that the son could not force the S Corp to pay out to him. The court then valued the real estate company at $3.36 million, 50% of which was the son’s; but that amount was further reduced by 50%, because it was a non-controlling interest. The son had apparently bought a condo out of company funds and his father had taken away the company checkbook, and with it some of the son’s decision making powers. The wife appealed both the discounted income figure and the discounted business value. The Montana Supreme Court held that “whether a discount is proper depends on the facts of the case, not the method used to ascertain the underlying value of the stock.” The court found that in fact the son had say over the company’s finances and operations, and, as evidence of this, he used company funds for personal purposes often. Furthermore, the son’s lack of control with respect to the payouts to himself was susceptible to substantial manipulation, and the trial court’s decision increased the potential and incentive for such manipulation. The case was remanded for an “objective determination of child support based on the husband’s actual tax returns, the company’s financial statements, and other relevant information. Discounts were found to be improper, and the entire value of the husband’s marital interest in the real estate company was subject to apportionment.
Can Gift Tax and Income Tax be Equated?
Pierre v. Commissioner, 2009 WL 2591652 (U.S. Tax Ct.)
Parents want to take the best possible financial care of their children. Sometimes their efforts come close to, or cross over, a legal line. Using family LLCs to gift assets and cash to one’s children is one such place where the risk arises.
At an appeal a tax court panel of 15 judges were split 9-6 on preserving a family LLC for gift vs. income tax purposes. In Pierre v. Commissioner, 2009 WL 2591652 (U.S. Tax Ct.) (Aug. 24, 2009), at issue was the “check-the-box” regulations, which provide that the entity form of a single-member LLC is disregarded for federal income tax purposes. The IRS argued to extend the same regulations so that a single-member (family) LLC is ignored for federal gift tax purposes as well.
The taxpayer had formed a family LLC and two trusts for her son and grandchild. Twelve days after funding the LLC, she exchanged her entire interest for the trusts, giving each a 40.5% membership, in return for promissory notes in amounts reflecting discounts for lack of marketability and control. The taxpayer concluded that no gift tax was due. The IRS assessed deficiencies of over $1 million.
A majority of the tax court disagreed with this assessment. They found that the taxpayer did not have a property interest in the LLC’s underlying assets, because New York law, under which the LLC was properly formed, recognized the entity separate and apart from her and its member, and “Federal law could not create a property right in those assets.” The court went on to say that the IRS could not “overrule” the federal gift tax regime with an over-broad interpretation of the check-the-box regulations. Six of the 15-member court dissented, leaving open a strong possibility of appeal by the IRS.
Family LLC is Really Conduit for Indirect Gift
Heckerman v. Commissioner, 2009 WL 2240326 (W.D. Wash)
The Pierre family was more fortunate than the Heckermans, whose family LLC was found, under the step-transaction doctrine, to have been a conveyance of property to their children for the sole purpose of minimizing their tax liability. In Heckerman v. Commissioner, 2009 WL 2240326 (W.D. Wash) (July 27, 2009), the parents wanted to pass property to their young children that would make them “work for their money” without triggering a gift tax.
On January 11, 2002, they transferred mutual fund investments to an LLC, owned wholly by a family LLC; transferred units in the family LLC to each of their children; signed gift documents stating that the assignments were effective on that date; provided the IRS with a document stating that the childrens’ trusts were admitted as members to the family LLC, effective on that date; and provided an appraisal of the valuation of the gift transfer, also effective on that date. Some time earlier, the parents had transferred real estate to the family LLC.
The “plethora” of evidence that all the transfers (regarding the cash, not the real estate) took place on the same day led the court to agree with the IRS and conclude that the cash transfers were in reality “indirect gifts of the proportionate amount of cash…to each child’s trust.” The IRS was granted summary judgment.
