T.C. Memo. 2011-297
UNITED STATES TAX COURT
RAY FELDMAN, TRANSFEREE, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 26737-08, 27386-08, Filed December 27, 2011.
27387-08, 27388-08,
27389-08, 27390-08,
27391-08, 27392-08,
27393-08.
Robert Edward Dallman, for petitioners.
George W. Bezold, for respondent.
1
Cases of the following petitioners are consolidated
herewith for opinion: Sharon L. Coklan, Transferee, docket No.
27386-08; Jill K. Reynolds, Transferee, docket No. 27387-08; Jan
Reynolds, Transferee, docket No. 27388-08; Carrie Donahue,
Transferee, docket No. 27389-08; Rhea Dugan, Transferee, docket
No. 27390-08; Emma McClintock, Transferee, docket No. 27391-08;
Robert Donahue, Transferee, docket No. 27392-08; and Richard
Feldmann, Transferee, docket No. 27393-08.
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MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: In these consolidated cases respondent
determined transferee liability against petitioners relating to
an agreed and unpaid $593,979 Federal income tax liability of
Woodside Ranch Resort, Inc. (Woodside Ranch), for 2002, plus an
addition to tax, penalties, and interest relating to Woodside
Ranch’s unpaid 2002 Federal income tax liability. The amount of
each petitioner’s respective transferee liability as calculated
by respondent is as follows: Ray Feldman--$542,514; Sharon L.
Coklan--$117,013; Jill K. Reynolds--$42,550; Jan Reynolds--
$212,751; Carrie Donahue--$95,738; Rhea Dugan--$41,274; Emma
McClintock--$95,738; Robert Donahue--$21,275; and Richard
Feldmann--$309,765.
The transferee liability determined against each petitioner
is based largely on respondent’s conclusion that a purported July
18, 2002, sale2 by petitioners of shares of stock in Woodside
Ranch constituted a sham transaction not dissimilar from the
abusive tax-avoidance transaction described in Notice 2001-16,
2001-1 C.B. 730 (referred to as an intermediary transaction).
2
In our findings of fact, use of the words “sale”,
“purchase”, and similar words generally is for convenience and is
not intended to and does not constitute a finding that the
referenced transactions constituted a valid transaction to be
recognized for Federal income tax purposes.
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The issue for decision is whether petitioners are liable
under section 6901 as transferees for their respective shares of
Woodside Ranch’s $593,979 Federal income tax liability for 2002,
plus the addition to tax, penalties, and interest.3
FINDINGS OF FACT
Many of the facts have been stipulated and are so found.
At the time of filing their separate petitions, petitioners
resided in Wisconsin, Florida, and Arizona. Trial was held on
November 17, 2010, in Milwaukee, Wisconsin.
In the 1920s Woodside Ranch was established and began
business as a Wisconsin corporation with its place of business in
Mauston, Wisconsin.
From its incorporation until May of 2002 Woodside Ranch
owned and operated a dude ranch resort offering, among other
activities, horseback riding, swimming, boating, hiking, fishing,
snow skiing, and snowmobiling, along with accommodations.
The historic shareholders in Woodside Ranch were William
Feldman and his five children. In 2002, at the time of the
transactions before us, Woodside Ranch stock was owned by 10
shareholders, 9 of whom were grandchildren or great-grandchildren
of William Feldman. They are petitioners herein. The 10th
3
Unless otherwise indicated, all section references are to
the Internal Revenue Code applicable to the year before us, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
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shareholder, Lucille Nichols, daughter of William Feldman, has
died, and her estate is not involved in these consolidated cases.
Just before the 2002 transactions involved in these cases,
the officers of Woodside Ranch were: President--decedent Lucille
Nichols; vice president--Richard Feldmann; secretary--Ray
Feldman; and treasurer--Carrie Donahue. These same individuals
also were the directors of Woodside Ranch.
On average, each year 6 to 20 accidents resulting in
injuries to customers occurred at Woodside Ranch. Only a few of
these accidents resulted in formal claims against Woodside Ranch.
The injuries that occurred at Woodside Ranch typically were not
serious, and personal injury claims were satisfied by Woodside
Ranch with in-kind compensation (e.g., free return visits to the
ranch for the injured customers and their families) plus the
payment by Woodside Ranch of medical expenses. After the
transactions described below that occurred in the spring and
summer of 2002, only one personal injury claim against Woodside
Ranch resulted in a payment to an injured customer. That payment
was for $50,000.
Although the sporting and other activities at Woodside Ranch
involved some risk of personal injury for Woodside Ranch
customers, over the years Woodside Ranch did not obtain
comprehensive personal injury insurance covering potential
injuries. Such comprehensive insurance was available but
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expensive, and management of Woodside Ranch chose not to purchase
it. Woodside Ranch did carry several insurance policies that
covered some activities at the ranch.4 As stated, for many years
including 2002 Woodside Ranch management was unwilling to pay the
high cost of comprehensive liability insurance covering
participant sports activities.
Sale of Woodside Ranch’s Assets
In the late 1990s and early 2000s the owners and management
of Woodside Ranch faced significant challenges to the continued
operation of the ranch: Increased competition from Wisconsin
casinos and water parks; aging of the Woodside Ranch shareholders
and directors; and lack of interest on the part of the
shareholders and the Feldman next generation in continued
operation of the ranch. As a result, the shareholders of
Woodside Ranch began a search for a buyer of either their stock
in Woodside Ranch or of the assets of Woodside Ranch.
The shareholders were interested in minimizing the tax
liabilities associated with a sale of their interests in Woodside
Ranch. A corporate asset sale would trigger significant Federal
and State corporate income tax liabilities.5
4
For example, Woodside Ranch carried landlord/tenant-type
insurance relating to the buildings and property.
5
In an opinion letter, Woodside Ranch’s accountant estimated
that a sale of Woodside Ranch assets would trigger Federal and
State corporate income taxes of approximately $595,700 and
(continued...)
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In the fall of 2001 negotiations began with an individual
named Damon Zumwalt (Zumwalt) for the sale of Woodside Ranch,
with the expectation on both sides that commercial operation of
the dude ranch would be continued by Zumwalt. A stock sale was
proposed to Zumwalt, who “just laughed and chuckled and said,
‘not on your life, it’s got to be an asset sale’.”
On May 17, 2002, after several months of negotiations, the
operating assets and business of Woodside Ranch were sold to
Woodside Ranch, LLC (WRLLC), for $2.6 million in cash
(hereinafter often referred to as the asset sale or the Zumwalt
asset sale). Zumwalt was the sole owner and sole member of
WRLLC. On this asset sale, the net cash proceeds received by
Woodside Ranch were $2,301,089.
In a June 5, 2002, memorandum to the Woodside Ranch
shareholders, petitioner Ray Feldman referred to the above
estimated taxes as posing a “dilemma” for the shareholders.
Also, Woodside Ranch management and shareholders were aware that
under Wisconsin law they might be able to limit their individual
liability relating to potential personal injury claims of
customers arising from ranch activities if the sale of Woodside
Ranch took the form of a stock sale with the new owners of the
5
(...continued)
$152,000, respectively.
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Woodside Ranch stock assuming the liabilities of Woodside Ranch,
including risks relating to potential personal injury claims.6
The total combined Federal and State income tax liability
that Woodside Ranch incurred on the asset sale was approximately
$750,000, of which the officers, directors, and shareholders of
Woodside Ranch at all relevant times were aware.
After the asset sale to Zumwalt, Woodside Ranch had no
operating assets and ceased to engage in any meaningful business
activity.
Efforts To Avoid Payment of Tax Liabilities
In the early spring of 2002 Fred Farris (Farris), an
accountant and financial adviser to Woodside Ranch and to some of
the individual shareholders, introduced the Woodside Ranch
officers, directors, and shareholders to MidCoast Credit Corp.
and to MidCoast Acquisition Corp. (collectively MidCoast).
MidCoast was owned directly or indirectly 50 percent by Michael
Bernstein and 50 percent by Honora Shapiro.
Representatives of MidCoast claimed to have expertise in tax
matters and provided to the Woodside Ranch officers promotional
materials which outlined a potential tax-avoidance transaction as
an alternative to a liquidation of Woodside Ranch.
6
If a liquidation of Woodside Ranch occurred, creditors
would be able to bring claims directly against Woodside Ranch
shareholders who received corporate assets on the liquidation.
See Wis. Stat. Ann. sec. 180.1408(2) (West 2002).
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Under the transaction presented by the MidCoast
representatives, the shareholders of Woodside Ranch allegedly
would be relieved of a significant portion, if not all, of
Woodside Ranch’s combined Federal and State income tax liability
of approximately $750,000 relating to the Zumwalt asset sale.
On June 11, 2002, in spite of the MidCoast promotional
materials that had been received, the Woodside Ranch finance
committee, consisting of petitioners Carrie Donahue, Ray Feldman
and Richard Feldmann, met and adopted a resolution recommending
that a plan of liquidation for Woodside Ranch be adopted.
However, the Woodside Ranch board of directors did not adopt
the recommended plan of liquidation, and the Woodside Ranch
directors chose instead to pursue the alternative tax-avoidance
transaction proposed by MidCoast mentioned above and described
more specifically below.
As reflected in written notations of petitioner Ray Feldman
of a meeting that apparently occurred later in the day on June
11, 2002, the MidCoast representatives explained that under the
MidCoast proposal MidCoast would purchase bad debts from entities
unrelated to target corporations (such as Woodside Ranch) and
would use the bad debts to offset or eliminate unpaid tax
liabilities of the newly acquired target corporations. The
MidCoast representatives explained that the “Income comes in tax
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free by using NOL”, and “So * * * [you] create * * * [a] loss--
lower deferred tax liability”. (Emphasis added.)
On June 17, 2002, MidCoast representatives explained over
the phone to Woodside Ranch officers that if Woodside Ranch was
not liquidated and if the cash Woodside Ranch received on the
Zumwalt asset sale was not distributed directly to the
shareholders, but instead the shareholders agreed to sell to
MidCoast their Woodside Ranch stock, MidCoast would pay to the
MidCoast shareholders a “‘premium’ of approximately $200,000 to
250,000” for their stock (hereinafter sometimes referred to as
the MidCoast premium).
The MidCoast premium that the Woodside Ranch shareholders
would receive was to be calculated as a percentage (between 25
and 33 percent) of the approximate combined Federal and State
corporate income tax liability Woodside Ranch had incurred as a
result of the Zumwalt asset sale. Notations reflecting the
MidCoast representations explain: “The exact figure for the
premium would be set on a percentage formula based upon the
amount of State and Federal tax owed as a result of sale of
Woodside assets to Damon Zumwalt and Woodside Ranch, LLC.”
Representatives of MidCoast repeatedly explained to the
Woodside Ranch officers that if the Woodside Ranch stock was sold
to MidCoast or to a MidCoast-related entity, MidCoast or its
related entity would obtain bad debt losses from other companies
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and use those losses to offset or eliminate the tax liabilities
of Woodside Ranch.
The transaction proposed by the representatives of MidCoast
was also referred to by the MidCoast representatives as a “no-
cost liquidation”. (Emphasis added.) In other words, instead of
directly liquidating Woodside Ranch and distributing to the
Woodside Ranch shareholders the cash proceeds from the Zumwalt
asset sale (less the combined Federal and State tax liability
that would have been paid), the MidCoast proposal was designed so
that the cash, in effect, still could be “liquidated” or
transferred to the Woodside Ranch individual shareholders, but
indirectly and via a few additional steps, as follows: A
purported or nominal sale of the Woodside Ranch stock to
MidCoast; a transfer by MidCoast to the Woodside Ranch individual
shareholders of the cash that would have been distributed to the
shareholders on a direct liquidation of Woodside Ranch (i.e., the
net proceeds available from Woodside Ranch for a liquidating
distribution plus a “premium”--one-third of the taxes owed); and
MidCoast would avoid paying the tax liabilities the Woodside
Ranch shareholders would have had to pay on a direct liquidation.
All this allegedly was to be made possible by MidCoast’s use of
bad debt losses from other companies to offset the reportable
Woodside Ranch gain on the Zumwalt asset sale.
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On June 17, 2002, Woodside Ranch’s finance committee met and
adopted a resolution to pursue further with the shareholders the
sale of Woodside Ranch’s stock to MidCoast as proposed in the
MidCoast promotional materials.
As reflected in minutes of a June 17, 2002, Woodside Ranch
finance committee meeting, the amount MidCoast would pay the
Woodside Ranch shareholders for 100 percent of the outstanding
Woodside Ranch stock would not be based on the value of the
Woodside Ranch stock. (Such a valuation would have included the
approximate $1.8 million in cash that Woodside Ranch had on hand
from the Zumwalt sale.) Rather, the minutes state that the
amount to be paid would be based on the premium or a percentage
(approximately 33 percent) of the taxes due on the Zumwalt sale.
The minutes state as follows:
[T]he sale of 100% of the stock of Woodside Ranch
Resorts, Inc., shareholders to MidCoast Investments,
Inc. in exchange for a “premium” of approximately
$200,000 to $250,000. The exact figure or total
amount of the payment for the premium would be set
on a percentage formula based upon the amount of
State and Federal tax owed as a result of sale of
Woodside assets * * *.
As described in the above minutes, the proposal from
MidCoast to pay approximately $250,000 for 100 percent of the
Woodside Ranch stock was not tied to the value of Woodside Ranch
stock or to the $1.8 million in cash that Woodside Ranch had on
hand, but on a split of Woodside Ranch’s tax liabilities intended
to go unpaid or be offset via the use of net operating losses
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(NOLs). In the above minutes, no mention is made of the cash
Woodside Ranch held from the Zumwalt asset sale.
The minutes of the June 17, 2002, finance committee meeting
also state that, upon a purchase by MidCoast, Woodside Ranch
would
become part of * * * [MidCoast’s] staple of companies
that they are supervising for the purpose of utilizing
tax losses which they acquired by buying credit card
companies bad debts and losses to offset against
profitable “C Corps” who have a situation like
Woodside’s wherein a large tax * * * [liability exists]
* * *.
The obvious and only benefit to MidCoast and its owners was
that they would end up with cash in their pockets equal to two-
thirds of the amount of Woodside Ranch’s unpaid tax liabilities.
During the weeks that the Woodside Ranch representatives
were in discussion with the MidCoast representatives, Woodside
Ranch representatives made a number of phone calls and undertook
to find out information about MidCoast. However, we are not
convinced, and in our opinion the credible evidence in these
cases does not establish, that the Woodside Ranch shareholders
and their representatives undertook a sufficiently in-depth and
thorough due diligence investigation of MidCoast.
On June 18, 2002, MidCoast sent a letter of intent to
Woodside Ranch in which MidCoast represented that--on the basis
of 30 percent of the Woodside Ranch estimated $750,000 combined
Federal and State tax liability--the Woodside Ranch shareholders
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together would receive approximately $210,000 more if the nominal
stock sale to MidCoast was used, thereby converting the
liquidation into the referred-to “no-cost” liquidation. The
following comparison chart was included in the letter of intent
to estimate roughly the promised benefits of the MidCoast
transaction:
Shareholders
Sell Stock of
Company to
Shareholders MidCoast [The
Liquidate Company “No Cost”
w/out MidCoast Liquidation]
Asset Sales Proceeds $2,600,000 $2,600,000
Less: Federal & State
Income Taxes (747,704) (747,704)
Less: RE Commission (117,000) (117,000)
Less: Title Insurance (2,000) (2,000)
Less: Notes Payable (318,400) (318,400)
Less: Misc. Adjustments (8,000) (8,000)
Net Proceeds Available
to Shareholders 1,406,896 N/A
Plus: MidCoast Premium
to Shareholders N/A 224,311
MidCoast Stock
Purchase Price [or
“Net Proceeds Available
to Shareholders”] N/A 1,631,207
On June 19, 2002, petitioner Ray Feldman sent a letter to
the other Woodside Ranch shareholders discussing, among other
things, MidCoast’s proposal. Specifically, petitioner Ray
Feldman noted:
The assets * * * [were] sold by the deed and bill of
sale on May 17th to [WRLLC] which of course is owned by
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Damon Zumwalt. Therefore, the corporation Woodside
Ranch Resort, Inc. is basically an “empty shell” but
which consists of the cash at the time of sale of Two
Million Two Hundred Seventy Six Thousand eighty-eight
Dollars and fifty-six cents.
* * * * * * *
MidCoast promises * * * to pay Woodside’s taxes because
the corporation would not be liquidated but instead be
kept alive as a going concern as part of the MidCoast
organization. This deal is profitable for MidCoast
because MidCoast purchases large amounts of defaulted
and delinquent credit card amounts from the major
credit card companies * * * and carries forward such
losses to offset against the purchase of “profitable”
corporations such as Woodside.
On the basis of the above evidence we have summarized (and
contrary to some testimony and documentary evidence in these
cases), it is absolutely clear that all individuals involved with
Woodside Ranch and MidCoast were aware that MidCoast and its
representatives had no intention of ever paying the tax
liabilities of Woodside Ranch and also that the source of the
approximately $225,000 MidCoast premium to be received by the
Woodside Ranch shareholders was to come from the unpaid tax
liability.
On June 27, 2002, a limited liability company was formed
under the name of Woodsedge, LLC (Woodsedge), with the Woodside
Ranch shareholders as its sole members, each having the same
ownership percentage in Woodsedge as they had in Woodside Ranch.
On July 11, 2002, petitioners Ray Feldman and Richard
Feldmann met with MidCoast representatives and others to discuss
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further the terms of the proposed purchase of the Woodside Ranch
stock by MidCoast, referred to as a share purchase agreement
(SPA). During that meeting, petitioners raised a question about
their exposure to transferee liability relating to Woodside
Ranch’s tax liabilities.
On July 18, 2002, for reasons not clear in the trial record,
Woodside Ranch redeemed 154 of the outstanding shares of Woodside
Ranch stock and distributed therefor to its shareholders $300,326
in cash and other assets (the redemption proceeds). The parties
explain that the fair market value of the redemption proceeds was
later reduced to $293,728, and the total redemption proceeds were
assigned and transferred by the Woodside Ranch shareholders to
Woodsedge.
After the above partial redemption and moments before the
effective date of the stock sale to MidCoast, Woodside Ranch had
$1,835,209 in cash on hand from the Zumwalt asset sale and an
approximate combined Federal and State income tax liability of
$750,000.
Also on July 18, 2002, the Woodside Ranch shareholders and
MidCoast entered into the SPA. Under the SPA, the stated
purchase price to MidCoast for the Woodside Ranch stock was
“equal to (a) the amount of Cash-on-Hand, less (b) $492,139.20”.
The $492,139.20 represented a percentage (roughly 70 percent) of
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the estimated “Deferred Tax Liabilities” of approximately
$750,000.
Still on July 18, 2002, in anticipation of the closing of
the SPA, two escrow agreements were executed: The first by
MidCoast, Woodside Ranch, the Woodside Ranch shareholders, and
the law firm of Foley & Lardner (Foley) (hereinafter referred to
as the sellers’ escrow agreement); the second by MidCoast, Honora
Shapiro (Shapiro), Shapiro’s attorney, and Foley (hereinafter
referred to as purchasers’ escrow agreement).
Under both escrow agreements Foley was to act as escrow
agent and all funds involved in the stock sale were to be wired
into and out of the same trust account of the Foley law firm (the
trust account).
On July 18, 2002, the following steps were taken:
(1) $1,835,209 (Woodside Ranch’s remaining cash on
hand from the Zumwalt asset sale and after the $300,326
cash redemption) was transferred into the trust
account;
(2) $1.4 million from Shapiro was transferred into
the trust account purporting to represent a loan from
Shapiro to MidCoast allegedly to fund the MidCoast
stock purchase;7
(3) the purported sale to MidCoast by the Woodside
Ranch shareholders of their remaining Woodside Ranch
stock closed;
7
The record does not indicate that the purported Shapiro
“loan” was evidenced by a promissory note, nor that Shapiro
received any security or collateral relating thereto.
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(4) $1,344,452 (viz., the $1,835,209 cash less the
$492,139 portion of the combined Federal and State tax
liability to be retained by MidCoast) (hereinafter
sometimes referred to as the Woodside Cash)8 was
transferred from the trust account into an account of
Woodsedge in favor of petitioners and which amount
included the approximate $225,000 MidCoast premium;
(5) $1.4 million was transferred back to Shapiro
in return of the purported loan Shapiro had made to
MidCoast earlier that same day (see (2) above); and
(6) $38,000 was transferred out of the trust
account to Foley for legal and escrow fees.9
Section 7.1 of the SPA states that the above cash transfers
were to be treated as occurring simultaneously. The schedule
below highlights the reality that the above cash transfers
occurred on the same day and within minutes or hours of each
other:
July 18, 2002 Event
12:09 p.m. $1,835,209 Woodside Ranch cash
transferred into the Foley trust
account;
1:34 p.m. $1.4 million cash purportedly lent
from Shapiro to MidCoast transferred
into the Foley trust account;
3:35 p.m. $1,344,451 cash transferred out of the
Foley trust account into an account of
Woodsedge in favor of petitioners;
8
Cash of $1,835,209 less $492,139 equals $1,343,070. The
record does not explain why an extra $1,382 was transferred from
the Foley trust account into the Woodsedge account in favor of
the Woodside Ranch shareholders.
9
Farris’ accounting firm also received a $25,000 finder’s
fee for introducing MidCoast to the Woodside Ranch shareholders.
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3:36 p.m. $1.4 million cash transferred out of
the trust account back to Shapiro.
Per the sellers’ escrow agreement, both the $1,344,451
(which petitioners received out of escrow on the purported sale
of their stock to MidCoast) and the $452,728.84 (which MidCoast
received) were to be paid, and they were paid from the sellers’
escrow fund into which was deposited the $1,835,209 proceeds from
the asset sale. In the sellers’ escrow agreement, no express
mention is made of any other funds being deposited into escrow to
be transferred to the sellers. We quote from the express
language of the sellers’ escrow agreement:
The Escrow Agent acknowledges receipt of the aggregate
amount of * * * $1,835,209.08 (such amount, less
distributions therefrom in accordance with this
Agreement, being referred to herein as the “Escrow
Fund”) from * * * [Woodside Ranch].
* * * * * * *
The Escrow Agent shall immediately on the Closing Date
* * * pay over to (A) Woodsedge on behalf of the * * *
[petitioners] from the Escrow Fund $1,344,451.52 by
wire transfer of immediately available funds to a bank
account of * * * [petitioners’] designation set forth
in the Instructions; (B) * * * [Woodside Ranch] from
the Escrow Fund $452,728.84 by wire transfer of
immediately available funds to a bank account of
* * * [Woodside Ranch’s] designation set forth in the
Instructions.
Per the purchaser’s escrow agreement, the purported $1.4
million loan from Shapiro was not to be disbursed until the
$1,835,209 proceeds of the Woodside Ranch asset sale were placed
into the escrow fund, and only then was: $1,344,351 to be
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disbursed to Woodsedge on behalf of the Woodside Ranch
shareholders; $452,728.84 to be disbursed to Midcoast; and $1.4
million to be “immediately” returned to Shapiro without interest.
The closing statement shows $1.4 million coming from Shapiro and
going back to Shapiro as part of the very same closing
transaction.
The $1.4 million from Shapiro came into escrow only
momentarily and went right back to Shapiro without ever serving a
legitimate, economic purpose in this transaction. Were it a
legitimate loan, the $1.4 million would have been outstanding for
a period of time and would have had some business purpose.
Interest would have been charged. There would have been a
written promissory note. The $1.4 million from Shapiro
constitutes a ruse, a recycling, a sham.
Within 4 days after the SPA closed, the $452,729 balance in
the trust account was transferred out of the trust account into a
SunTrust bank account in the name of Woodside Ranch, which by
that point in time was controlled by MidCoast.
On or about July 22, 2002, April 2003, and August 8, 2005,
each of the individual Woodside Ranch shareholders received from
Woodsedge his or her respective share of the $293,728 redemption
proceeds and of the $1,344,451 cash that passed through the Foley
trust account as described above.
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Included in the SPA was a representation by the shareholders
of Woodside Ranch that, as of the time of the SPA, Woodside Ranch
had no liabilities, direct or contingent, other than the combined
Federal and State tax liability.
Included in the SPA was a guarantee and release in favor of
petitioners to the effect that, as between petitioners and
MidCoast, the maximum amount MidCoast could seek from petitioners
relating to personal injury claims made by customers of Woodside
Ranch was equal to the $224,311 MidCoast premium (i.e., to the
portion of the taxes that were to go unpaid and that were to be
retained by petitioners).10
Also, the SPA contained a provision prohibiting MidCoast
from liquidating or dissolving Woodside Ranch within 4 years of
the July 18, 2002, closing of the stock sale.11
Woodside Ranch After the Closing of the Purported Stock Sale
After the purported stock sale to MidCoast, MidCoast was the
nominal sole shareholder of Woodside Ranch. Woodside Ranch had
$452,729 cash on hand, a combined Federal and State tax liability
10
As stated earlier, after the above transactions with
MidCoast, petitioners made only one payment relating to personal
injury claims arising from activities of Woodside Ranch before
July 18, 2002, which resulted in a payment by petitioners and
others of $50,000.
11
Petitioners presumably wanted this provision both as added
protection against potential personal injury claims arising from
Woodside Ranch activities and to protect against petitioners’
personal exposure to transferee liability for Woodside Ranch’s
unpaid income tax liabilities relating to the asset sale.
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of approximately $750,000, and no operating assets. Woodside
Ranch was rendered insolvent as a result of the payment by it of
the redemption proceeds, the payment of the Woodside cash to the
Woodside Ranch shareholders, and the return to Shapiro of his
$1.4 million.
After the above transactions with MidCoast, Woodside Ranch
had no paid employees and no income (other than nominal interest
income). However, MidCoast charged Woodside Ranch a
“professional service fee” of $250,000, and from August to
December 2002 MidCoast charged Woodside Ranch $30,000 per month
as a management fee, even though there were essentially no assets
to manage. Woodside Ranch’s SunTrust account records show
withdrawals of $300,000 and $142,000 on July 19 and 22, 2002,
respectively. As a result of these withdrawals, Woodside Ranch
was unable to pay the July or August 2002 management fees it
nominally owed MidCoast.
An amount of $1,181,249 was entered on the books of Woodside
Ranch as a loan due from MidCoast to Woodside Ranch. This
purported loan receivable in favor of Woodside Ranch apparently
was based on the treatment of the $1.4 million in cash that, on
July 18, 2002, was returned out of the Foley trust account to
Shapiro. Woodside Ranch and MidCoast treated part (i.e.,
$1,181,249) of the $1.4 million returned to Shapiro as if it had
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been returned to Shapiro not by MidCoast, but by Woodside Ranch
and that MidCoast somehow owed Woodside Ranch $1,181,249.
In December of 2003 MidCoast purportedly sold all of the
stock of Woodside Ranch to Wilder Capital Holdings, LLC (Wilder),
for no cash and for the “assumption” by Wilder of MidCoast’s
purported $1,181,249 loan obligation to Woodside Ranch.
Wilder made no payment on this purported loan assumption,
and within 1 month, by January 29, 2004, the purported $1,181,249
loan and a promissory note of Wilder’s relating thereto were
marked “paid”.12
On September 12, 2003, Woodside Ranch’s 2002 Federal
corporate income tax return was filed showing a tax due of
$454,292, all relating to the Zumwalt asset sale. By that time,
Woodside Ranch, of course, had no funds, and Woodside Ranch’s
Federal income tax liability was not paid with the filing of the
return.
On February 22, 2005, Woodside Ranch’s 2003 Federal
corporate income tax return was filed claiming a net operating
loss (NOL). This claimed NOL was carried back to 2002 and
thereby reduced Woodside Ranch’s reported 2002 Federal income tax
liability to zero.
12
Wilder’s obligation on the assumed purported Midcoast debt
to Woodside Ranch should have been, were it legitimate, reflected
in a promissory note running from Wilder in favor of Woodside
Ranch. In fact, however, a promissory note of Wilder relating
thereto was issued in favor of MidCoast.
- 23 -
Woodside Ranch was administratively dissolved on August 13,
2009.
On audit, respondent disallowed all but $5,432 of the 2003
NOL claimed by Woodside Ranch on the grounds that the NOL was
based on sham loans and was part of an illegal distressed
asset/debt (DAD) tax shelter. Petitioners have stipulated that
this DAD tax shelter was illegal, that the claimed 2003 NOL was
not allowable, and that respondent properly disallowed the NOL
carryback to 2002.13
On September 11, 2006, respondent sent to Woodside Ranch a
notice of deficiency setting forth respondent’s determination of
Woodside Ranch’s $594,000 Federal income tax deficiency for 2002
plus an estimated tax penalty under section 6654, delinquency
additions to tax under section 6651(a)(2) and (3), and an
accuracy-related penalty under section 6662(b)(1). Woodside
Ranch did not file a petition in this Court challenging the
13
Generally, in a DAD tax shelter a domestic partnership
claims a loss relating to a purported contribution of a built-in
loss asset. The partnership typically will contribute the asset
to a lower tier partnership, which in turn will sell that asset
to another (sometimes related) entity, thereby purportedly
incurring a significant loss. The reported loss passes through
to the upper tier partnership, which allocates and passes through
the loss to the domestic partners; the domestic partners offset
other income or gain with the purported loss. The overall effect
is that the domestic partner-taxpayers reap the benefits of the
built-in loss asset without ever having incurred the costs
associated therewith. See IRS Coordinated Issue Paper,
“Distressed Asset/Debt Tax Shelters”, LMSB-04-0407-031 (Apr. 18,
2007).
- 24 -
notice of deficiency, nor did Woodside Ranch file a complaint in
any other court relating to its 2002 Federal income tax
liability.
Petitioners took no actions to ensure that the Woodside
Ranch Federal income tax liability triggered by the Zumwalt asset
sale would be paid14 and, as stated, it remains unpaid.15
Respondent investigated whether Woodside Ranch had any
available assets from which to collect Woodside Ranch’s unpaid
2002 Federal income tax liability and determined that it had
none.
On September 15, 2008, respondent sent notices of transferee
liability to petitioners, each notice identifying Woodside Ranch
as the transferor with an unpaid Federal income tax liability of
approximately $594,000 plus additions to tax, penalties, and
14
Sec. 2.11 of the SPA provided that
All Taxes due and payable by the Company on or prior to
the Closing Date, including without limitation those
which are called for by the Tax Returns, or heretofore
claimed to be due by any taxing authority from the
Company, have been paid, except for the Deferred Tax
Liability, which liability is assumed by the Purchasers
hereunder.
Sec. 2.9 of the SPA defines “Deferred Tax Liability” and
apparently limits it to $703,056.
15
It should be noted that the Woodside Ranch $153,725
Wisconsin corporate income tax liability for 2002 was paid by
MidCoast when MidCoast representatives learned (apparently to
their surprise) that Wisconsin law did not permit NOL deductions
to be carried back and to offset prior year State corporate
income tax liabilities.
- 25 -
interest for a total of $1,057,216. The transferee notices
indicated the total amount each petitioner received in the stock
redemption and purported stock sale and calculated each
petitioner’s individual transferee liability accordingly.
An attachment to each notice of transferee liability stated
in relevant part:
It is determined that the transaction in which
shareholders of Woodside Ranch Resort, Inc. purportedly
* * * sold stock of Woodside Ranch Resort, Inc. to
MidCoast Acquisitions Corporation and MidCoast Credit
Corporation on July 18, 2002 is not respected for tax
purposes. This transaction is substantially similar to
an Intermediary transaction shelter described in notice
2001-16, 2001-1 C.B. 730 and Notice 2008-20, 2008-6
I.R.B. 406.
It is determined that, in substance, Woodside Ranch
Resort, Inc. ceased business activity on July 18, 2002,
and that the allocation set forth in Exhibit 1 [showing
petitioners’ share of the deemed transferred assets] is
attributable to you in liquidation or distribution of
assets of Woodside Ranch Resort, Inc. on that date.16
OPINION
In determining whether petitioners are liable under section
6901 as transferees for Woodside Ranch’s unpaid Federal income
tax liability, we first consider whether the July 18, 2002,
purported stock sale between petitioners and MidCoast is, for
Federal income tax purposes, to be recognized as such or is to be
treated as a sham.
16
Petitioners do not contest their liability as transferees
relating to the $293,729 redemption proceeds they received.
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Economic Substance or Sham
Taxpayers generally are free to structure their business
transactions as they wish, even if motivated in part by tax
reduction considerations. Gregory v. Helvering, 293 U.S. 465
(1935); Rice’s Toyota World, Inc. v. Commissioner, 81 T.C. 184,
196 (1983), affd. on this issue 752 F.2d 89 (4th Cir. 1985).
However, a transaction which lacks economic purpose and
substance other than sought-after tax avoidance may be treated as
a sham and disregarded for Federal income tax purposes. Frank
Lyon Co. v. United States, 435 U.S. 561 (1978); Rice’s Toyota
World, Inc. v. Commissioner, supra at 196. The economic
substance of a transaction, rather than its form, controls.
Commissioner v. Court Holding Co., 324 U.S. 331 (1945); Gregory
v. Helvering, supra; Amdahl Corp. v. Commissioner, 108 T.C. 507,
516-517 (1997).
The “labels, semantic technicalities, and formal written
documents do not necessarily control the tax consequences of a
given transaction.” Houchins v. Commissioner, 79 T.C. 570, 589
(1982); see also Ocmulgee Fields, Inc. v. Commissioner, 613 F.3d
1360, 1368 (11th Cir. 2010), affg. 132 T.C. 105 (2009); Teruya
Bros., Ltd. v. Commissioner, 580 F.3d 1038, 1043 (9th Cir. 2009),
affg. 124 T.C. 45 (2005); Yosha v. Commissioner, 861 F.2d 494,
499 (7th Cir. 1988), affg. Glass v. Commissioner, 87 T.C. 1087
(1986).
- 27 -
As we recently stated, for Federal income tax purposes a
transaction may be disregarded if the transaction was entered
into not for valid business purposes but rather for “tax benefits
not contemplated by a reasonable application of the language and
purpose of the Code or its regulations.” Palm Canyon X Invs.,
LLC v. Commissioner, T.C. Memo. 2009-288. Even if a transaction
is not treated as a sham, it still may be recast in order to
reflect its true nature. Gaw v. Commissioner, T.C. Memo. 1995-
531 (citing Packard v. Commissioner, 85 T.C. 397, 419-422
(1985)), affd. without published opinion 111 F.3d 962 (D.C. Cir.
1997).
Courts often interpret the Supreme Court’s holding in Frank
Lyon Co. v. United States, supra, as establishing an economic
substance doctrine with two prongs: Whether the taxpayer had a
nontax business purpose or objective for entering into the
disputed transaction (the subjective prong); and whether the
transaction had economic substance beyond the anticipated tax
benefits (the objective prong). See, e.g., Karr v. Commissioner,
924 F.2d 1018, 1023 (11th Cir. 1991), affg. Smith v.
Commissioner, 91 T.C. 733 (1988); Bail Bonds by Marvin Nelson,
Inc. v. Commissioner, 820 F.2d 1543, 1549 (9th Cir. 1987), affg.
T.C. Memo. 1986-23; Rice’s Toyota World, Inc. v. Commissioner,
752 F.2d at 91-92; Palm Canyon X Invs., LLC v. Commissioner,
supra.
- 28 -
Some courts use a disjunctive approach and treat a
transaction as having economic substance if the transaction has
either a business purpose or economic substance. See, e.g.,
Rice’s Toyota World, Inc. v. Commissioner, 752 F.2d at 91-92.
Some courts use a conjunctive approach and treat a transaction as
having economic substance only if the transaction has both a
business purpose and economic substance. See, e.g., Dow Chem.
Co. v. United States, 435 F.3d 594, 599 (6th Cir. 2006). Yet
other courts collapse the objective and subjective prongs into
one comprehensive inquiry. See, e.g., Sacks v. Commissioner, 69
F.3d 982, 988 (9th Cir. 1995), revg. T.C. Memo. 1992-596;
Kirchman v. Commissioner, 862 F.2d 1486, 1492 (11th Cir. 1989),
affg. Glass v. Commissioner, 87 T.C. 1087 (1986).
The Court of Appeals for the Seventh Circuit has stated
generally that “It is well-established that the Commissioner is
not required to recognize, for tax purposes, those transactions
which lack economic substance.” Muhich v. Commissioner, 238 F.3d
860, 864 (7th Cir. 2001), affg. T.C. Memo. 1999-192.
“[T]ransactions with no economic substance don’t reduce people’s
taxes.” Cemco Investors, LLC v. United States, 515 F.3d 749, 752
(7th Cir. 2008); Grojean v. Commissioner, 248 F.3d 572 (7th Cir.
2001), affg. T.C. Memo. 1999-425; Muhich v. Commissioner, supra
at 864 (citing Gregory v. Helvering, supra); see also Coleman v.
- 29 -
Commissioner, 16 F.3d 821 (7th Cir. 1994), affg. T.C. Memo. 1990-
99 and T.C. Memo. 1987-195.
The Court of Appeals for the Eleventh Circuit recently noted
that “Even if the transaction has economic effects, it must be
disregarded if it has no business purpose and its motive is tax
avoidance.” United Parcel Serv. of Am., Inc. v. Commissioner,
254 F.3d 1014, 1018 (11th Cir. 2001); see also Kirchman v.
Commissioner, supra at 1492 (“The focus of the inquiry under the
sham transaction doctrine is whether a transaction has economic
effects other than the creation of tax benefits.” (citing Knetsch
v. United States, 364 U.S. 361 (1960))). In Kirchman v.
Commissioner, supra at 1492, the Court of Appeals for the
Eleventh Circuit noted further:
The analysis of whether a transaction is a substantive
sham, however, addresses whether a transaction’s
substance is that which it form represents. That does
not necessarily require an analysis of a taxpayer’s
subjective intent. Once a court determines a
transaction is a sham, no further inquiry into intent
is necessary.
The Court of Appeals for the Ninth Circuit has recently
discussed in an unpublished opinion the economic substance
doctrine and its two prongs as follows: “‘(1) whether * * *
[taxpayers] demonstrated that either of the principals directing
their respective transactions had a business purpose for engaging
in the transaction other than tax avoidance and (2) whether
either transaction had economic substance beyond the creation of
- 30 -
tax benefits.’” Thomas Inv. Partners, Ltd. v. United States, 108
AFTR 2d 2011-5369, at 2011-5371, 2011-2 USTC par. 50,517, at
86,287 (9th Cir. 2011) (quoting Casebeer v. Commissioner, 909
F.2d 1360, 1363 (9th Cir. 1990)).
The Court of Appeals in Thomas concluded that the
transactions under scrutiny were unlikely to confer a nontax
benefit and that the individuals who engaged in those
transactions did so solely to create tax benefits. Id. at 2011-
5372, 2011-2 USTC par. 50,517, at 86,287. Further, the Court of
Appeals has stated that “the consideration of business purpose
and economic substance are simply more precise factors to
consider in the application of this court’s traditional sham
analysis”. Sochin v. Commissioner, 843 F.2d 351, 354 (9th Cir.
1988), affg. Brown v. Commissioner, 85 T.C. 968 (1985).
Before us in these cases is a purported stock sale between
petitioners and MidCoast that lacks both business purpose and
economic substance and that we conclude is to be disregarded for
Federal income tax purposes. In substance, there was no sale of
the stock of Woodside Ranch; rather, Woodside Ranch was
liquidated, and the $1,835,209 cash that Woodside Ranch had on
hand (after the partial redemption that occurred on July 18,
2002) was distributed to the Woodside Ranch shareholders less a
fee of approximately $500,000 that MidCoast retained for
facilitating the sham.
- 31 -
The “no-cost liquidation” terminology used by the MidCoast
representatives is telling. In substance, it really was a
liquidation, not a stock sale. The effort, assisted by
MidCoast’s sleight of hand, to reduce the tax cost of the
Woodside Ranch liquidation by cloaking the liquidation in the
trappings of a stock sale is to be ignored.
We emphasize that at the same time Shapiro transferred $1.4
million into the trust account, $1.4 was immediately returned to
Shapiro. Inferentially, the approximately $1.3 million the
Woodside Ranch shareholders received out of the trust account
came to them from the $1.8 million in proceeds of the Zumwalt
asset sale--as a corporate distribution. In substance, Woodside
Ranch was liquidated, and petitioners received the $1.3 million
as liquidation proceeds.
The $1,181,249 reported loan receivable in favor of Woodside
Ranch from MidCoast obviously was a mere accounting device,
devoid of substance. As we have emphasized, the $1.4 million
Shapiro placed into the escrow on July 18, 2002, was returned to
Shapiro 2 hours later, and thereafter no portion thereof was owed
by anyone to anyone. Shapiro had his $1.4 million. MidCoast did
not owe him anything. Woodside Ranch did not owe him anything,
and MidCoast did not owe Woodside Ranch anything with regard
thereto.
- 32 -
What was transferred by Woodside Ranch to MidCoast did not
actually represent equity in Woodside Ranch. See Owens v.
Commissioner, 568 F.2d 1233, 1238 (6th Cir. 1977), affg. in part
and revg. in part 64 T.C. 1 (1975). On July 18, 2002, Woodside
Ranch’s assets consisted only of cash. All of the operating
assets and business of Woodside Ranch had been sold to Zumwalt.
After the asset sale and partial redemption, but before the
purported stock sale, Woodside Ranch had $1,835,209 cash on hand
and a combined Federal and State corporate income tax liability
of approximately $750,000.
From the time of the purported stock sale, Woodside Ranch
carried on no business activity; there was no viable business to
continue, and, on the basis of our evaluation of the evidence and
testimony before us, representations from MidCoast that Woodside
Ranch would be incorporated into MidCoast’s “asset-recovery”
business are preposterous.
After the July 18, 2002, transaction, Woodside Ranch was
nothing more than a shell, with no employees, no real property,
and no assets other than MidCoast’s share of the unpaid taxes.
Petitioners argue emphatically that if Woodside Ranch had
been liquidated, Woodside Ranch’s management and shareholders
might have ended up facing unexpected and unknown claims and
lawsuits against them personally under Wisconsin law. Indeed,
petitioners argue that the Woodside Ranch shareholders’ concern
- 33 -
over potential liability claims was dominant and that the
shareholders’ concern over taxes due on the Zumwalt asset sale
was only secondary.
As we have found, however, whatever the level of perceived
risk the Woodside Ranch management and shareholders actually had
in operating Woodside Ranch, it was not enough of a risk to
convince them to purchase anything more than spotty or discrete
personal injury insurance.
Over the years, Woodside Ranch had relatively few personal
injury claims brought against it relating to activities of the
ranch and then only in amounts not disclosed in the record.
On the facts and credible evidence before us, we conclude
that petitioners had little basis for being concerned for their
potential personal liability on unknown claims and lawsuits
arising out of the activities of Woodside Ranch.17
The June 17, 2002, minutes of the Woodside Ranch finance
committee meeting establish that both the MidCoast
representatives and the Woodside Ranch shareholders knew and
17
We also find it remarkable that the Woodside Ranch
shareholders and MidCoast capped the liability of the Woodside
Ranch shareholders for personal injury claims relating to ranch
activities to the amount of the MidCoast premium (i.e., to the
amount the shareholders were to receive from the unpaid taxes).
Apparently, the individuals involved in the transactions before
us thought the unpaid taxes (or a portion thereof) should be the
measure not only of MidCoast’s fee, but also the measure and
limit of the shareholders’ liability for personal injury claims.
The unpaid taxes were to serve dual purposes.
- 34 -
understood that the only real payment MidCoast was making to the
Woodside Ranch shareholders was calculated as, and in fact
constituted, nothing more than a split of the projected tax
liabilities that no one intended to pay.
The real price to be paid by MidCoast for the stock had
nothing to do with the value of Woodside Ranch; rather, the stock
purchase by Midcoast was a sham, and MidCoast was simply
splitting between itself and the Woodside Ranch shareholders the
amount of the taxes that should have been paid.
The MidCoast representative said it correctly when he stated
that the transaction before us was all about creating tax
avoidance; it was not supported by underlying economic substance
and business activity. The only entity that was to fund, or
incur, the cost of the transaction before us was the Federal
Government via unpaid taxes.
Petitioners argue that the SPA provision under which
Woodside Ranch was not to be dissolved for 4 years confirms their
good faith and intent that the tax liabilities would be paid, and
confirms their concern over personal liability for personal
injury claims against Woodside Ranch. We disagree. We regard
the SPA provision as essentially meaningless. While under the
control of MidCoast, Woodside Ranch failed to pay its taxes,
claimed other illegal tax-avoidance tax shelters, and was
effectively given away by MidCoast for nothing.
- 35 -
We conclude that in substance the transaction before us was
not a bona fide sale of Woodside Ranch stock. The substance of
the transaction was a liquidation to petitioners of Woodside
Ranch’s cash and a fee payment to MidCoast for its role in
facilitating the sham.
Transferee Liability
Section 6901(a) provides a procedure through which
respondent may collect from transferees of assets unpaid taxes
owed by the transferors of the assets if a legal basis exists
under State law or equity for holding the transferees liable for
the unpaid taxes. Commissioner v. Stern, 357 U.S. 39, 42-47
(1958); Hagaman v. Commissioner, 100 T.C. 180, 184-185 (1993).
Transferee liability under section 6901 includes related
additions to tax, penalties, and interest owed by the
transferors. Kreps v. Commissioner, 42 T.C. 660, 670 (1964),
affd. 351 F.2d 1 (2d Cir. 1965). Respondent bears the burden of
proving that petitioners are liable as transferees of the
property of Woodside Ranch. See sec. 6902(a); Rule 142(d).
We apply Wisconsin law in our analysis of whether
petitioners should be held liable as transferees of Woodside
Ranch.
Wisconsin shareholders of a dissolved corporation may be
liable as transferees to creditors of the corporation (such as
respondent) where the shareholders receive corporate assets as
- 36 -
part of a dissolution. Wis. Stat. Ann. sec. 180.1408(2) (West
2002) provides:
If the dissolved corporation’s assets have been
distributed in liquidation, a claim not barred under
sec. 180.1406 or 180.1407 may be enforced against a
shareholder of the dissolved corporation to the extent
of the shareholder’s proportionate share of the claim
or the corporate assets distributed to him or her in
liquidation, whichever is less, but a shareholder’s
total liability for all claims under this section may
not exceed the total amount of assets distributed to
him or her. As computed for purposes of this
subsection, the shareholder’s proportionate share of
the claim shall reflect the preferences, limitations
and relative rights of the class or classes of shares
owned by the shareholder as well as the number of
shares owned, and shall be equal to the amount by which
payment of the claim from the assets of the corporation
before dissolution would have reduced the total amount
of assets to be distributed to the shareholder upon
dissolution.
Income tax liabilities arising from the sale of corporate
assets are “claims” existing at the time of the sale. See Kreps
v. Commissioner, supra at 670-671. This Court has held that at
the time of an intermediary transaction asset sale (not
dissimilar from the transaction herein), the Commissioner
qualified as a creditor of the seller for Federal taxes arising
from the sale. LR Dev. Co., LLC v. Commissioner, T.C. Memo.
2010-203 (discussing Illinois definitions of the terms “debt” and
“claim” which are the same as under Wisconsin’s fraudulent
transfer statute).
Having found that the transaction before us in substance and
purpose was part of a liquidation and dissolution of Woodside
- 37 -
Ranch and that the Woodside Ranch shareholders received, as a
part of that liquidation and dissolution, approximately $1.3
million in cash as a distribution from Woodside Ranch, we
conclude that petitioners are liable as transferees under the
above provision of Wisconsin law for their proportionate shares
of Woodside Ranch’s unpaid 2002 Federal income tax liability.
Wisconsin also has adopted the Uniform Fraudulent Transfer
Act, codified at Wis. Stat. Ann. secs. 242.01 to 242.12 (West
2009) (Wisconsin UFTA), which provides creditors with certain
remedies where a debtor transfers property and thereby avoids
creditor claims. If the elements of the Wisconsin UFTA are
satisfied, creditors may obtain an attachment or other remedy
against the property transferred and against the transferees and
their property. Wisconsin UFTA sec. 242.07.
Respondent does not argue that petitioners should be liable
as transferees under Wisconsin UFTA section 242.04(1)(a), a
provision that requires a debtor’s actual intent to defraud,
hinder, or delay a creditor. However, respondent argues that
under two closely related provisions of the Wisconsin UFTA
petitioners should be treated as transferees and as liable for
the unpaid Federal income tax liability of Woodside Ranch.
Wisconsin UFTA section 242.04(1)(b) is applicable where:
[T]he debtor made the transfer or incurred the
obligation: * * * Without receiving a reasonably
equivalent value in exchange for the transfer or
obligation, and the debtor: (1) Was engaged or was
- 38 -
about to engage in a business or a transaction for
which the remaining assets of the debtor were
unreasonably small in relation to the business or
transaction; or (2) Intended to incur, or believed or
reasonably should have believed that the debtor would
incur, debts beyond the debtor's ability to pay as they
became due.
Wisconsin UFTA section 242.05(1) is applicable where:
[T]he debtor made the transfer or incurred the
obligation without receiving a reasonably equivalent
value in exchange for the transfer or obligation and
the debtor was insolvent at that time or the debtor
became insolvent as a result of the transfer or
obligation.
Wisconsin statutes do not define “reasonably equivalent
value”. The Uniform Fraudulent Transfer Act is a uniform act
deriving the phrase “reasonably equivalent value” from 11 U.S.C.
section 548. Leibowitz v. Parkway Bank & Trust Co. (In re Image
Worldwide, Ltd.), 139 F.3d 574, 577 (7th Cir. 1998); Bowers-
Siemon Chems. Co. v. H.L. Blachford, Ltd., 139 Bankr. 436, 445
(Bankr. N.D. Ill. 1992) (“Illinois law on fraudulent conveyance
parallels sec. 548 of the Bankruptcy Code.”). Whether reasonably
equivalent value was received by the transferor is a question of
fact. Leibowitz v. Parkway Bank & Trust Co. (In re Image
Worldwide, Ltd.), supra at 576 (citing Heritage Bank Tinley Park
v. Steinberg (In re Grabill), 121 Bankr. 983, 994 (Bankr. N.D.
Ill. 1990)).
In the bankruptcy context, the Court of Appeals for the
Seventh Circuit has stated that the “test used to determine
reasonably equivalent value in the context of a fraudulent
- 39 -
conveyance requires the court to determine the value of what was
transferred and to compare it to what was received.” Barber v.
Golden Seed Co., 129 F.3d 382, 387 (7th Cir. 1997).
Under the Wisconsin UFTA, creditors, such as respondent,
have the burden to prove the above elements of transferee
liability by clear and convincing evidence. Kaiser v. Wood Cnty.
Natl. Bank & Trust Co. (In re Loyal Cheese Co.), 969 F.2d 515,
518 (7th Cir. 1992); Mann v. Hanil Bank, 920 F. Supp. 944, 950
(E.D. Wis. 1996).
Petitioners do not dispute Woodside Ranch’s liability for
the Federal income taxes arising from the Zumwalt asset sale, nor
the existence of respondent’s claim therefor or respondent’s
creditor status at the time of the transfers in question.
On the evidence before us, it is clear that in exchange for
the distribution of approximately $1.3 million in cash to
petitioners Woodside Ranch received nothing of reasonably
equivalent value.
After the Zumwalt asset sale, Woodside Ranch ceased to
engage in any business activity. There was no viable business to
continue, and regardless of how MidCoast chose to describe its
post-sale intentions for Woodside Ranch, the only “business” left
for Woodside Ranch was to pay its tax liabilities arising from
the asset sale. The transfer of Woodside Ranch’s $1.3 million to
petitioners left Woodside Ranch with remaining assets of
- 40 -
approximately $453,000 in cash, insufficient to pay Woodside
Ranch’s Federal and State income tax liabilities exceeding
$700,000.
It is clear that as a result of Woodside Ranch’s cash
distribution to petitioners, Woodside Ranch was rendered
insolvent. See Wisconsin UFTA sec. 242.02(b)(2) (“A debtor is
insolvent if the sum of the debtor’s debts is greater than all of
the debtor’s assets at a fair valuation.”).
Further, the Woodside Ranch shareholders should have known
that the Federal income tax liability arising from the Zumwalt
asset sale would not be paid. The credible evidence before us
establishes that petitioners’ interest in the MidCoast
transaction relied almost entirely on the assumption and
calculation that the Woodside Ranch tax liability would remain
unpaid; the impetus for taking the cumbersome route of a nominal
stock sale was the mutual understanding between petitioners and
MidCoast that each party would pocket and retain a portion of the
unpaid taxes.
MidCoast offered a “no-cost” liquidation as a solution to
the tax “dilemma” in which petitioners found themselves. In
spite of representations to the contrary in some of the
transaction documents, the record is replete with notice to
petitioners that MidCoast never intended to pay Woodside Ranch’s
Federal income tax liability.
- 41 -
On the credible evidence before us, we conclude that
petitioners knew or should have known that, as a result of the
transactions among Woodside Ranch, MidCoast, and petitioners,
Woodside Ranch had debts beyond its ability to pay.
We conclude that petitioners herein are liable as
transferees under both of the above provisions of the Wisconsin
UFTA for their proportionate shares of Woodside Ranch’s unpaid
2002 Federal income tax liability.
Lastly, under what respondent refers to as a common law
“trust fund” doctrine relating to fiduciary duties of corporate
directors and officers, petitioners should be treated as
transferees and as liable for the unpaid Federal income tax
liability of Woodside Ranch. Respondent cites Beloit Liquidating
Trust v. Grade, 677 N.W.2d 298, 309 (Wis. 2004), which explained
that when a corporation is insolvent and has ceased to be a going
concern and its directors and officers know, or ought to know,
that suspension of the corporation is pending, transfers of
corporate property to the directors or officers in lieu of
payments to creditors of the corporation may be held to
constitute a fraud on the creditors and the directors and
officers may be held personally liable to the injured creditors.
See also Polsky v. Virnich, 779 N.W.2d 712, 714 (Wis. Ct. App.
2010).
- 42 -
Under the above alternate authority, respondent argues that
all petitioners should be held liable under Wisconsin law and
under section 6901 as transferees. As noted, however, this
Wisconsin common law authority would apply only to petitioners
who were directors and officers of Woodside Ranch (namely, to Ray
Feldman, Richard Feldmann, and Carrie Donahue), not to
petitioners who were neither directors nor officers of Woodside
Ranch.
In light of our conclusion and holding herein that
petitioners are liable under Wis. Stat. Ann. sec. 180.1407, the
Wisconsin UFTA, and section 6901 for their respective shares of
Woodside Ranch’s 2002 unpaid Federal income tax liability, we
need not, and we do not decide whether any petitioners also
should be held liable under the above common law authority on
which respondent relies.
In two recent Memorandum Opinions and in a Memorandum
Opinion filed today, this Court has addressed transferee
liability relating to other transactions promoted by Midcoast.
See Frank Sawyer Trust of May 1992 v. Commissioner, T.C. Memo.
2011-298 (filed Dec. 27, 2011); Starnes v. Commissioner, T.C.
Memo. 2011-63 (decision entered Mar. 24, 2011), on appeal (4th
Cir., June 8, 2011); Griffin v. Commissioner, T.C. Memo. 2011-61
(decision entered Sept. 30, 2011). In the above three cases this
- 43 -
Court held in favor of the taxpayers. Those cases involved
differences from the instant cases.
Starnes and Frank Sawyer Trust were decided largely on the
basis of insufficiency of and burden of proof.
In Griffin, after the transaction with MidCoast, the target
corporation retained substantial assets and was not thereby
rendered insolvent. Additionally, the taxpayer filed a lawsuit
and obtained a State court judgment against MidCoast in an effort
to get the taxes paid.
In Starnes, Griffin, and Frank Sawyer Trust, the facts as
found did not establish that the taxpayers knew that MidCoast
intended not to pay the taxes.
For the reasons stated, we sustain respondent’s
determination that petitioners are liable as transferees with
respect to their respective shares of the 2002 unpaid Federal
income tax liability of Woodside Ranch and the related additions
to tax, penalties, and interest.
Decisions will be entered
for respondent.