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IRS Can't Collect Taxes from Heiresses Prodded into Stock Deal by Tax Advisers.
(Parker Tax Publishing June 13, 2014)

Three sisters, who were co-trustees of several trusts holding millions of dollars of appreciated stock, were not liable for the unpaid taxes of the company that purchased the stock; there was no indication that the sisters or their trusts were part of the plan to avoid taxes. Swords Trust v. Comm'r, 142 T.C. No. 19 (5/29/14).

Julia Swords, Margaret Mackell, and Dorothy Brotherton were co-trustees of three trusts set up by their father, son of the founder of Reynolds Metal Co., maker of Reynolds Wrap. The main assets of each trust were shares of Davreyn, a personal holding company (PHC) incorporated in Virginia. Before June 2000, Davreyn held a substantial number of shares in Reynolds Metal. In June 2000, Reynolds Metal merged with Alcoa, Inc., and Davreyn's Reynolds Metal shares were converted into Alcoa shares. As of February 1, 2001, Davreyn held shares of Alcoa stock and an investment in the Goldman Sachs 1999 Exchange Place Fund (Goldman Sachs fund). In February 2001, the value of the Alcoa stock held by Davreyn exceeded $14 million. Robert Griffin, a CPA, provided accounting and tax services to the trusts for decades.

In the late 1990s, the accounting firm of BDO Seidman advised its local offices about an opportunity for PHC shareholders to sell their appreciated PHC stock to a financial buyer in a tax efficient manner. Robert Griffin was advised of the opportunity by Tom Rohman at McGuireWoods LLP. Rohman, learning of the plan himself from BDO. Although Julia, Margaret, and Dorothy had not previously considered selling the trusts' shares in Davreyn, arranging a sale of Davreyn's assets, or liquidating Davreyn, they agreed, on the advice of Griffin and Rohman, to sell the trusts' Davreyn stock to the financial buyer. Rohman did not discuss the buyer's plans with respect to either Davreyn or Davreyn's assets.

According to Rohman, upon the sale of the Davreyn stock, the trusts would recognize long-term capital gain in amounts equal to the difference between the total stock sale price and the trusts' tax bases in the stock. The sale went through, and the trusts paid their tax liability. However, Davreyn opened a foreign bank account and transferred its Alcoa stock to the newly opened account and then liquidated under Code Sec. 331. After engaging in what the IRS termed a SON-OF-BOSS transaction, the buyers reported a net loss on the transaction. Upon an audit of the buyers and Davreyn, the IRS rejected the claimed losses and assessed additional taxes. When the IRS couldn't collect from Davreyn or Davreyn's buyers, it went after Julia, Dorothy, and Margaret.

The IRS determined that each sister's trust was liable under Code Sec. 6901 for transferee liability and assessed a total of over $10 million in taxes, interest, and penalties. Under Code Sec. 6901(a), the IRS can proceed against a transferee of property (i.e., the sisters who received money from the stock sale) to assess and collect federal income tax, penalties, and interest owed by the transferor. A transferee under Code Sec. 6901 includes, among other persons, a shareholder of a dissolved or liquidated corporation.

The end result of the transaction was that the buyers purchased all of the Davreyn stock from the trusts so that they could acquire Davreyn's then principal asset, the Alcoa stock. The purchasing corporations, the IRS said, engaged in a preplanned series of interrelated transactions designed to illegitimately avoid tax on the sale of Davreyn's Alcoa stock. According to the IRS, the sisters' trusts' sales of their Davreyn stock were part of a plan by those trusts to illegitimately avoid corporate tax on the distribution of the Alcoa stock upon Davreyn's liquidation. The IRS argued that the court had to apply the following two-step analysis in determining whether the sisters' trusts were liable for Davreyn's unpaid tax: (1) analyze whether the subject transactions should be recast under federal law using the federal substance-over-form doctrine, and then (2) apply Virginia law, specifically Virginia's trust fund doctrine, to the transactions as recast under federal law.

The Tax Court rejected the IRS's arguments and held that the trusts owned by the sisters did not have transferee liability under Code Sec. 6901. The court also concluded that Code Sec. 6901 required the court to apply state rather than federal law to determine whether a transaction is recast under a substance-over-form (or similar) doctrine. When the trusts sold their Davreyn stock, the court noted, neither the trusts nor their representatives knew that the buyer planned to dissolve Davreyn. When Davreyn was dissolved, no one associated with the trusts had any role in structuring the sale of the Alcoa stock or in deciding to dissolve Davreyn. The trusts, the court observed, had no interest in Davreyn when it was dissolved because they had already sold all of their Davreyn stock. Nor, the court noted, was Davreyn insolvent when the trusts sold their Davreyn stock. Further, the court stated, neither the trusts nor Davreyn's directors attempted to avoid any existing debt of Davreyn. Thus, the court concluded that the IRS failed to establish that an independent basis existed under Virginia law or Virginia equity principles for holding the trust's liable for Davreyn's unpaid tax.

For a discussion of transferee liability under Code Sec. 6901, see Parker Tax ¶262,530. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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