SCOTUS Reports

Tag: Section 1374

  • Anschutz Co. v. Comm’r, 135 T.C. 78 (2010): Tax Treatment of Prepaid Variable Forward Contracts and Share-Lending Agreements

    Anschutz Co. v. Commissioner, 135 T. C. 78 (2010)

    The U. S. Tax Court ruled that the Anschutz Company must recognize gain from its stock transactions involving prepaid variable forward contracts (PVFCs) and share-lending agreements (SLAs) with DLJ. The court determined that these transactions constituted a sale for tax purposes due to the transfer of benefits and burdens of ownership, despite the company’s attempt to treat them as open transactions. The ruling clarifies the tax implications of such financial arrangements, impacting how similar transactions might be structured in the future to avoid immediate tax recognition.

    Parties

    Plaintiffs: Anschutz Company (Petitioner), Philip F. and Nancy P. Anschutz (Petitioners). Defendants: Commissioner of Internal Revenue (Respondent). The Anschutz Company was the trial-level plaintiff, and the case was appealed to the U. S. Tax Court, where they remained petitioners.

    Facts

    Philip F. Anschutz, the sole shareholder of Anschutz Company, used The Anschutz Corporation (TAC), a qualified subchapter S subsidiary of Anschutz Company, to hold stocks from various companies he invested in. In 2000 and 2001, TAC entered into a master stock purchase agreement (MSPA) with Donaldson, Lufkin & Jenrette Securities Corp. (DLJ) to sell shares of Union Pacific Resources Group, Inc. (UPR), Anadarko Petroleum Corp. (APC), and Union Pacific Corp. (UPC). The MSPA included both PVFCs, where DLJ made an upfront cash payment in exchange for TAC’s promise to deliver a variable number of shares in the future, and SLAs, which allowed DLJ to borrow the shares subject to the PVFCs. The upfront payments were calculated at 75% of the stock’s fair market value, and TAC received an additional 5% as a prepaid lending fee. TAC did not report any gain or loss from these transactions on its federal income tax returns.

    Procedural History

    The Commissioner of Internal Revenue issued notices of deficiency to Anschutz Company and Philip F. Anschutz for the tax years 2000 and 2001, determining that the MSPA transactions constituted closed sales of stock and thus were subject to built-in gains tax under section 1374. Anschutz Company and Philip F. Anschutz filed petitions with the U. S. Tax Court to contest these determinations. The Tax Court consolidated the cases and held a trial on February 9-10, 2009. The standard of review applied was de novo, as the case involved factual determinations and legal interpretations.

    Issue(s)

    Whether the transactions entered into by TAC under the MSPA with DLJ constituted a sale under section 1001 of the Internal Revenue Code, requiring the recognition of gain to the extent of the upfront cash payments received in 2000 and 2001?

    Whether the transactions resulted in a constructive sale under section 1259 of the Internal Revenue Code?

    Rule(s) of Law

    Section 1001(a) of the Internal Revenue Code provides that the gain from the sale or other disposition of property shall be the excess of the amount realized over the adjusted basis. Section 1058(a) provides that no gain or loss shall be recognized on the transfer of securities pursuant to an agreement that meets the requirements of section 1058(b), which includes not limiting the transferor’s risk of loss or opportunity for gain. Section 1259(a)(1) provides that a constructive sale of an appreciated financial position requires recognition of gain as if the position were sold at its fair market value on the date of the constructive sale.

    Holding

    The U. S. Tax Court held that the transactions under the MSPA constituted a sale under section 1001, requiring TAC and Anschutz Company to recognize gain to the extent of the upfront cash payments received in 2000 and 2001. The court further held that the transactions did not result in a constructive sale under section 1259.

    Reasoning

    The court analyzed the MSPA as an integrated transaction, finding that TAC transferred the benefits and burdens of ownership of the stock to DLJ, including legal title, all risk of loss, a major portion of the opportunity for gain, the right to vote the stock, and possession of the stock. The court rejected the argument that the SLAs and PVFCs were separate transactions, noting that the MSPA required the execution of both. The court also found that the SLAs did not meet the requirements of section 1058(b) because the MSPA limited TAC’s risk of loss through the downside protection threshold, which guaranteed that TAC would not have to return any portion of the upfront payment even if the stock’s value fell. The court determined that TAC must recognize gain only to the extent of the cash received in 2000 and 2001, rejecting the Commissioner’s argument that TAC received value equal to 100% of the stock’s fair market value. Regarding the constructive sale under section 1259, the court found that the PVFCs were not forward contracts for a substantially fixed amount of property, as the number of shares deliverable could vary by up to 33. 3%, which was deemed substantial.

    Disposition

    The U. S. Tax Court ordered that decisions would be entered under Rule 155, requiring the recognition of gain to the extent of the upfront cash payments received by TAC in 2000 and 2001.

    Significance/Impact

    The decision in Anschutz Co. v. Commissioner clarifies the tax treatment of complex financial transactions involving PVFCs and SLAs. It establishes that such transactions can be treated as sales for tax purposes if they transfer the benefits and burdens of ownership, even if the parties intended to treat them as open transactions. The ruling impacts the structuring of similar financial arrangements and may lead to increased scrutiny by the IRS of transactions that attempt to defer tax recognition. The case also highlights the importance of analyzing all aspects of an integrated transaction, rather than treating components as separate for tax purposes.

  • Coggin Automotive Corp. v. Commissioner, T.C. Memo. 2001-123: ‘Most Recent Election’ Rule for S Corp Built-In Gains Tax

    Coggin Automotive Corp. v. Commissioner, T.C. Memo. 2001-123 (2001)

    When a corporation revokes its S corporation election and later re-elects S status, the ‘most recent election’ rule of Section 1374(d)(9) of the Internal Revenue Code applies, subjecting the corporation to the built-in gains tax for a new 10-year period based on the re-election date, regardless of a prior S election before 1989 and associated transition rules.

    Summary

    Coggin Automotive Corp., initially a C corporation, elected S corporation status in 1988. It revoked this election in 1989 and operated as a C corporation until re-electing S status in 1994. During 1994-1996, the IRS assessed deficiencies against Coggin, arguing that gains from asset sales were subject to the built-in gains tax under Section 1374 as amended by the Tax Reform Act of 1986 (TRA). Coggin argued that the transition rule of TRA Section 633(d) should apply because its initial S election was before 1989. The Tax Court held that Section 1374(d)(9), as amended, explicitly refers to the ‘most recent election,’ which was the 1994 re-election, thus subjecting Coggin to the amended built-in gains tax rules for a new 10-year period. The transition rule was deemed inapplicable due to the intervening revocation of S status.

    Facts

    Coggin Automotive Corp. was incorporated in 1977 and operated as a C corporation until February 1, 1988, when it made a valid S corporation election. At the time of the 1988 election, Coggin held assets with unrealized gains and earnings and profits accrued during its C corporation years. These assets included securities, real estate interests, and oil and gas partnership interests. Effective December 1, 1989, Coggin revoked its S election and filed as a C corporation through 1993. On January 1, 1994, Coggin again made a valid S corporation election. During 1994-1996, Coggin sold assets, primarily acquired before 1988, generating gains.

    Procedural History

    The Internal Revenue Service (IRS) issued a notice of deficiency to Coggin for the tax years 1994, 1995, and 1996, asserting deficiencies related to the built-in gains tax. Coggin petitioned the Tax Court to dispute these deficiencies. The case was submitted to the Tax Court fully stipulated, meaning the parties agreed on all the factual details, and the court only needed to decide the legal issue.

    Issue(s)

    1. Whether the transition rule of Section 633(d) of the Tax Reform Act of 1986 applies to Coggin Automotive Corp. for the years 1994-1996, given that Coggin made an S election before 1989 but revoked and re-elected S status.

    2. Whether Section 1374 of the Internal Revenue Code, as amended by the Tax Reform Act of 1986, applies to Coggin’s 1994, 1995, and 1996 taxable years due to its 1994 S corporation re-election.

    Holding

    1. No, the transition rule of TRA Section 633(d) does not apply because Coggin’s S election was not continuous from before 1989 to the years in issue due to the revocation and subsequent re-election.

    2. Yes, Section 1374, as amended, applies because Section 1374(d)(9) explicitly states that references to the ‘1st taxable year for which the corporation was an S corporation’ refer to the ‘1st taxable year for which the corporation was an S corporation pursuant to its most recent election under section 1362.’ Coggin’s ‘most recent election’ was in 1994.

    Court’s Reasoning

    The Tax Court reasoned that the plain language of Section 1374(d)(9), as amended, is clear and unambiguous. The statute directs the court to consider the ‘most recent election’ when determining the applicability of the built-in gains tax. The court stated, “Section 1374, as amended, is applicable to the 10-year period after an S corporation’s ‘most recent election’. Sec. 1374(d)(9).” Coggin’s ‘most recent election’ was in 1994. The court rejected Coggin’s argument that the 1988 election and the transition rule should govern, emphasizing that the revocation of the S election in 1989 interrupted the continuity required for the transition rule to apply. The court noted that when Coggin became a C corporation in 1989, the transition rule became inapplicable. Upon re-electing S status in 1994, Coggin became subject to Section 1374 as amended and in effect at that time. The court also found that this interpretation was consistent with the legislative history of TRA Section 633, which aimed to tax built-in gains of corporations electing S status after 1986.

    Practical Implications

    Coggin Automotive Corp. clarifies that the ‘most recent election’ rule in Section 1374(d)(9) is strictly applied. For practitioners, this case highlights the importance of considering the built-in gains tax implications whenever a corporation re-elects S status after a revocation. Even if a corporation had an S election in place before the Tax Reform Act of 1986 and might have initially benefited from transition rules, a subsequent revocation and re-election resets the clock. The 10-year built-in gains tax period begins anew with the ‘most recent election.’ This decision emphasizes the need for careful tax planning when considering S corporation revocations and re-elections, particularly for corporations holding appreciated assets. It underscores that the IRS and courts will adhere to the literal language of Section 1374(d)(9), focusing on the most recent S election to determine the applicable tax regime.