Feb. 26, 2015 – The former family owners of a dude ranch in Mauston, northwest of Wisconsin Dells, must pay the unpaid tax and tax avoidance penalties for selling the ranch through a sham transaction, a three-judge panel for the U.S. Court of Appeals for the Seventh Circuit has ruled.
In Feldman et al. v. Commissioner of Internal Revenue, Nos. 12-3144 et al. (Feb. 24, 2015), the panel upheld the shareholders’ “transferee liability” for a stock sale that triggered “sham” transactions and the avoidance of capital gains tax on assets sold for $2.3 million.
The shareholders were 10 family descendants of William Feldman, who founded Woodside Ranch in the 1920s. Incorporated in 1952, the Woodside Ranch Resort Inc. operated as a dude ranch for nearly 50 years. But the owners decided to sell the ranch in the late 1990s. Since assets were purchased long ago, selling them would trigger a large tax on capital gains.
In 2002, Woodside Ranch Resort Inc. sold assets to the newly formed Woodside Ranch LLC in an asset purchase, which resulted in a capital gain of about $1.8 million. The tax bill on this gain amounted to about $750,000. Woodside Ranch Resort Inc. was now a shell corporation with asset proceeds, some outstanding receivables, and the outstanding tax liability.
Woodside Ranch Resort’s accountant and financial advisor then introduced the family shareholders to representatives from MidCoast Credit Corp. and Midcoast Acquisition Corp. (MidCoast), which specialized in structured transactions designed to minimize tax liabilities.
Ultimately, MidCoast purchased the company’s stock for about $1.35 million, which amounted to the company’s cash at closing reduced by about $492,000 (70 percent of the tax liability). A series of successive transactions included a “loan” to fund MidCoast’s stock purchase.
Woodside’s shareholders indicated a belief that MidCoast would assume the company’s tax liability and offset capital gain profits with carry over losses from its other ventures.
MidCoast, which later sold Woodside’s stock to a holding company, did not pay Woodside’s $454,000 tax liability for 2002, the year of the asset sale. In 2003, it claimed a net operating loss, carried back to 2002, wiping out the 2002 tax liability triggered by the asset sale.
In 2006, the IRS issued Woodside a notice of deficiency for the 2002 tax year. According to the appeals court opinion, the IRS determined “that the net operating loss was based on sham loans and was part of an illegal distressed asset/debt tax shelter.” Woodside did not respond.
In 2008, the IRS sent notices to the former Woodside owners, the Feldman descendants, assessing “transferee liability” under 26 U.S.C. section 6901, which allows the IRS to seek unpaid taxes and penalties against the transferees of delinquent taxpayers where transfers violate state law.
The shareholders stipulated that the transfers were shams, but contested “transferee liability.” The U.S. Tax Court upheld the IRS commissioner’s assessment of transferee liability, and the Seventh Circuit Court of Appeals affirmed that decision.
Looking at substance over form, the tax court found that the stock transaction was actually a liquidation of cash on hand that MidCoast funded with a sham loan to avoid taxes.
“Although the stock changes hands, the transaction lacked independent, nontax economic substance because Woodside had divested itself of all tangible assets and was not a going concern,” wrote Judge Diane Sykes, concluding the Woodside shareholders were “transferees” in this liquidation cloaked in a stock sale. “Its shares represented nothing more than the right to withdraw cash and the duty to pay taxes.”
The Woodside shareholders, as transferees, were liable for the tax because the transactions also violated Wisconsin’s fraudulent-transfer law, the panel explained.
That is, the shareholders merely cashed out the asset sale and Woodside did not receive equivalent value. In addition, the transaction left Woodside insolvent, and transactions cannot result in debtor insolvency.