Source: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/annotations/businessplanning/index.html
Timestamp: 2019-04-25 02:24:08+00:00

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IRS Says 2 Percent S Corporation Shareholder Can Claim Self-Employed Health Insurance Deduction. I.R.C. §1372 says that, for purposes of applying the provisions of the I.R.C. that relate to employee fringe benefits, an S corporation is treated as a partnership. Likewise, any 2 percent (as defined in I.R.C. §318 as owning more than two percent of the corporate stock) S corporation shareholder is treated as a partner in the partnership in accordance with I.R.C. §1372. An S corporation can deduct the cost of accident and health insurance premiums that the S corporation pays for or furnishes on behalf (i.e., reimburses) of its 2 percent shareholders. The two percent shareholders must include the amounts in gross income in accordance with Notice 2008-1, 2008-2 IRB 251 (i.e., the S corporation reports the amounts as wages on the shareholder’s W-2) provided that the shareholder meets the requirements of I.R.C. §162(l) and the S corporation establishes the plan providing medical care coverage. Under the facts of the CCA, a taxpayer owned 100 percent of an S corporation which employed the taxpayer’s family member. The family member is a two-percent shareholder under the attribution rules of I.R.C. §318. The S corporation provides a group health plan for all employees, and the amounts paid by the S corporation under the plan are included in the family members gross income. Provided the requirements of I.R.C. §162(l) are satisfied, the IRS determined that the family member could claim a deduction for the amounts the S corporation paid. Thus, the family member could convert what might be a nondeductible expense (because of either the 10 percent floor for medical expenses or because the family member takes the standard deduction) into an above-the-line deduction. C.C.A. 2019012001 (Dec. 21, 2018).
Consolidation of Ranch Holdings Legitimate Reason To Continue Trust. This case involves a family that has been involved in contentious litigation over a family trust. The case has been before the Wyoming Supreme Court on multiple occasions. The trust was created in 1989 and amended in 1995. The amendment provided for the appointment of a successor trustee; always required the service of two trustees; created a marital trust for the survivor of the settlors; and revised the buyout provision. The grantors and their five children made contributions to the trust. Upon the death of one of the grantors in 2007 one of the children was appointed as co-trustee. Ligation arose when the surviving grantor’s property was not conveyed to the trust and then again involving removal of the trustees, and an appointed trustee moved to have the trust terminated due to the administrative difficulties to administer, family dysfunction, and because the trust no longer served its purpose. The defendants, (including the co-trustee that resigned) asserted that termination was moot and moved to have the new co-trustee removed. The trial court did not remove the co-trustee and found that the trust was still valid. The trial court found that the co-trustee did not violate any fiduciary duties and that the defendants failed to show gross and willful misconduct to justify her removal. Further the trial court found that the co-trustee’s claims that the trust was invalid should have been raised in the original trust challenge. The trial court determined that the primary reason for the trust (to keep the lands and leases together for the Redland family) had not been frustrated and that the trust remained administratively functional and was not "unlawful, contrary to public policy, or impossible. On appeal, the Wyoming Supreme Court affirmed. The Court determined that the trust still had a purpose - to keep the ranch holdings together to conduct business. Even though the other purpose of minimizing tax consequences had failed, consolidation of ranch holdings remained a legitimate purpose. The Court also determined that the co-trustee did not violate her fiduciary duties, her duties of impartiality or loyalty, and that her actions did not amount to gross and willful misconduct. In addition, the Court found that the duty of impartiality did not require the trustee to treat all beneficiaries fairly, but simply to act in the best interest of the beneficiaries and equally defend the intentions of the settlors. While the Court could find no precedent with respect to the duty of loyalty the Court held that merely seeking termination of the trust was not a breach of loyalty. In addition, the Court determined that hostility between parties did not warrant removal. In re Redland Family Trust, 2019 WY 17 (2019).
Oil & Gas Investment Did Not Create Partnership. This case arose out of a speculative project to buy oil and gas leases, and the subsequent sale of them. At least ten investors were involved, including individuals and business entities, who contributed money and services towards the project in accordance with a “Participation Agreement.” In 2012, according to the terms of the agreement, the “partnership” purchased 30,000 mineral acres. While most of the investors were content with the initial purchase and sale of the 30,000 acres, three of the investors, the plaintiffs, decided to invest in further acreage by buying additional oil and gas leases to the exclusion of the “Partners” in the Participation Agreement. Additionally, some of the plaintiffs failed to make their required contribution to the initial purchase. At some point it came to light that the plaintiffs had sold leases on more than the initial 30,000 acres, but the proceeds of those sales were not shared with those involved in the Participation Agreement. Several investors sued in their individual capacities and ultimately alleged that the Participation Agreement resulted in the creation of a partnership known as Three Fingers Black Shale Partnership, the defendant. The defendant claimed the plaintiffs had breached fiduciary duties to the partnership by lying, cheating, and stealing, and that by means of creative accounting procedures had attempted to cover-up their activities. The result was that the defendant did not receive its rightful share of the profits from the sale of either the initial deal for 30,000 acres or in connection with the sales of additional acreage. After a three-week jury trial, the court awarded actual and exemplary damages in favor of the defendant, the purported partnership. On appeal, the primary issue was whether the Participation Agreement constituted the formation of a partnership. In answering that question, the appellate court looked at all of the facts and circumstances. The court found only a few factors showing existence of a partnership under the agreement, such as the right to receive a share in the profits and the right to participate in the control of the business. Additionally, in the agreement, the investors referred to themselves in some places as “Parties” and in others as “Partners.” While the court acknowledged these factors, it noted that the document establishing these factors was titled a “Participation Agreement” as opposed to a “Partnership Agreement,” and held that the agreement was merely an agreement whereby the parties agreed to participate in a project as investors rather than partners. Having found that no partnership existed, the appellate court reversed the actual and exemplary damages awarded to the partnership. The court also reversed the trial court on the breach of fiduciary duties claim. If the partnership did not exist, it could not be owed fiduciary duties. The appellate court remanded the case. Stephens v. Three Finger Black Shale Partnership, No. 11-16-00177-CV, 2018 Tex. App. LEXIS 10921 (Tex. Ct. App. Dec. 31, 2018).
Lack of Marketability Discount Applied for Limited Partnership Interest. Before death, the decedent had created an limited partnership under Texas law. The decedent held a one percent general partner interest and an 88.99 percent limited partner interest. Eight of the decedent’s family members owned the balance of the limited partner interests. The partnership didn’t conduct any meetings and held cash, equities, bonds and mutual funds. The decedent had the power to approve the sale of partnership interests and had a right of first refusal on all sales. The partnership agreement described persons who acquired partnership interests as “assignees.” A few years before death, the decedent purported to create an “assignee” interest in his revocable trust with respect to his 88.99 percent limited partnership interest. The decedent’s estate tax return reported the decedent’s limited partnership interest as an “assignee” of the revocable trust and claimed a 37.2 percent lack of marketability discount and lack of control. The estate based the level of the discount on the notion that the trust only held an assignee interest consistent with the partnership agreement which stated that, “A transferee who was not admitted as a substituted limited partner would hold the right to allocations and distributions with respect to the transferred interest, but would have no right to information or accounting or to inspect the books or records of the partnership and would not have any of the rights of a general or limited partner (including the right to vote on partnership matters)." The IRS reduced the extent of the discount and asserted a deficiency of about $500,000. While the estate claimed that the lack of marketability discount should be 27.5 percent based on a possible holding period until 2075, the Tax Court determined that the decedent’s assignee interest was essentially the same thing as a limited partnership interest. Accordingly, the Tax Court settled on an 18 percent discount for lack of marketability. No discount for lack of control was allowed because the Tax Court found that the partnership interest was significant and carried with it the power to remove the general partner. Streightoff v. Comr., T.C. Memo. 2018-178.
Farm Partnership Not Dissolved on Death of Partner. Two brothers were co-equal partners in a farming partnership. Upon the death of a partner, the partnership continued, but the estate of a deceased partner could not make business decisions without the surviving partner’s approval. Also, the written partnership agreement stated that, “Land owned as tenants in common by [the partners] is contributed to the partnership without charge. The partnership is responsible for all costs and management associated with the land and treats the land as if owned by the partnership. This contribution cannot be retracted except on dissolution of the partnership or agreement by both partners. Any land owned [by] other persons operated by the partnership is leased by the partnership and not by individual partners.” One of the partners died in 2012, and his will devised part of his land to his brother and the rest to his step children and nephew. The land that was devised to the step-children and nephew was burdened with a condition stating that the property should "be sold in a commercially reasonable manner so as to derive the most value therefrom within six (6) months of my death." In 2012 this land was conveyed to the children and they also requested partition and sale of the land held as co-tenants in the partnership. The defendant challenged the conveyance stating the estate should have sold the property rather than conveying it. In 2014 the trial court agreed and vacated the conveyance and returned the property to the deceased partner’s estate. The surviving partner continued to farm, and the deceased partner’s estate brought suit for rent due on the partnership property. The trial court denied the estate rent, stating that partnership was not liable for rent six months after the decedent’s death. They also determined that the agreement continued the partnership for six months so that the surviving partners could decide what to do. The trial court also held that the partnership lacked standing during the litigation between 2012 and 2014 over the conveyance because the estate did not own the property. Finally, the trial court held that the estate did not show that they were due relief as they could not show that the defendant was unjustly enriched. The estate appeals. On appeal, the appellate court affirmed in part, reversed in part, and remanded the case. The appellate court, based on the partnership agreement, determined that the partnership was not dissolved upon death, but that the estate became a partner that was owed profits and losses. The appellate court determined that the district court erred when interpreting the statement, "the partners intended that there be an extended time to deal with a partner leaving or the death of a partner before the necessary wind up of the partnership or its continuation by the remaining partners." The appellate court held that this did not invoke a dissolution and winding up period after one of their deaths. Because the appellate court held that the partnership was not dissolved, and the land was held as co-tenants, there was no rent due. The partnership was still valid, and the land was being used within the guidelines of the agreement. Since the use of the land was correct, the surviving partner was not unjustly enriched, bur was merely continuing the business as a partner. Thus, the appellate court affirmed that the estate was not due any rent between the decedent’s death and sale of the property. However, the estate may be still owed profits from the partnership. Since the estate became a partner, with limited abilities, the court remanded the case for an accounting of profits or losses after the decedent’s death. Estate of Moore v. Moore, 2018 N.D. 221 (2018).
Court Says Corporate Farming Law “Family Farm” Exception Unconstitutional. North Dakota law bars corporations, other than family farming corporations, from owning farm land and engaging in farming or agriculture. The specific statutory language states: “All corporations and limited liability companies, except as otherwise provided in this chapter, are prohibited from owning or leasing land used for farming or ranching and from engaging in the business of farming or ranching. A corporation or a limited liability company may be a partner in a partnership that is in the business of farming or ranching only if that corporation or limited liability company complies with this chapter.” However, by virtue of a 1981 amendment, the statute also states: “This chapter does not prohibit a domestic corporation or a domestic limited liability company from owning real estate and engaging in the business of farming or ranching, if the corporation meets all the requirements of chapter 10-19.1 or the limited liability company meets all the requirements of chapter 10-32.1 which are not inconsistent with this chapter.” This amended language became known as the “family farm exception” because it requires shareholders to have a close family relation who is actively engaged in the operation. Historically, the state attorney general and secretary of state have interpreted the “family farming” exception as a way to allow out-of-state family farming corporations to own farm land and conduct agricultural operations in North Dakota. However, the plaintiff, North Dakota’s largest farm group along with other family farming corporations challenged the law as written on the basis that the law violated the “Dormant Commerce Clause” as discriminating against interstate commerce. The court agreed, enjoining the State from enforcing the family farm exception against out-of-state corporations that otherwise meet the statutory requirements (which the State didn’t do anyway). North Dakota Farm Bureau, Inc. v. Stenehjem, No. 1:16-cv-137, 2018 U.S. Dist. LEXIS 161572 (D. N.D. Sep. 21, 2018).
Failure To Treat Corporation As Entity Separate From Owner Leads To Piercing Of Corporate Veil. The defendant formed a corporation and filed articles of incorporation in 1997. The corporation was reincorporated in 2001 after an administrative dissolution. The corporation was engaged in the business of biosolids management. The defendant was the sole owner and director of the corporation along with being the corporation’s secretary and treasurer. The plaintiff contracted with a small town to be as the general contractor during the construction of a wastewater treatment facility for the town. In early 2010, the plaintiff contracted with the defendant for lagoon sludge removal. The defendant began work, but then ceased work after determining that project would cost more to complete that what the contract was bid for. In 2012, the plaintiff sued for breach of contract and obtained a judgment of $410,066.83 plus interest in 2014. The corporation failed to pay the judgment and the plaintiff sued in 2015 to pierce the corporate veil and recover the judgment personally from the defendant. The trial court refused to pierce the corporate veil and also denied a request to impose a constructive trust and equitable lien on the corporate assets. The plaintiff appealed the denial of piercing the corporate veil. The appellate court determined that the plaintiff had failed to establish that the corporation was undercapitalized – it had assets and was profitable. The plaintiff also did not show that the corporation was undercapitalized at the time it entered into the contract with the plaintiff. There also was no evidence showing that the corporation changed the nature of its work or engaged in an inadequately-capitalized expansion of the business. It was also unclear, the appellate court noted, that the capital transfers from the corporation to the defendant rendered the initial adequate capitalization irrelevant. Thus, the plaintiff failed to establish that the corporation was undercapitalized to an extent that merited piercing the corporate veil. However, the appellate court noted that the evidence illustrated that the defendant commingled personal funds with corporate funds. The defendant used corporate funds for personal purposes, and also failed to maintain separate books and records that sufficiently distinguished them from the defendant personally. In addition, the appellate court noted that the corporation did not follow corporate formalities. The corporation had been dissolved administratively by the Secretary of State in 1998 due to the failure to file a biennial report, but that the corporation continued operations during the time it was dissolved as if the corporation were active. When the new corporation began in 2001, no bylaws, corporate minute book or shareholder ledger were produced. In addition, the new corporation (operating under the same name as the old corporation) was administratively dissolved three times for failure to submit the biennial report (the corporation used the statutory procedure to apply for reinstatement each time). The appellate court determined that the corporation was not considered by the defendant to be a separate entity from himself. Accordingly, the appellate court reversed the trial court and allowed the corporate veil to be pierced and the defendant to be held personally responsible for the judgment. Woodruff Construction, L.L.C. v. Clark, No. 17-1422, 2018 Iowa App. LEXIS 765 (Iowa Ct. App. Aug. 15, 2018).
S Corporation Election Inadvertently Terminated. A C corporation elected S corporate status and had retained earnings and profits from the prior C corporate years. The S corporation had three consecutive tax years in which its passive income exceeded 25 percent of gross receipts. As a result, the S election was terminated in accordance with I.R.C. §1362(d)(3)(A)(i). In addition, the S corporation was subject to the “sting” tax of I.R.C. §1375. However, the IRS determined that the S election was inadvertently terminated because the tax advisors involved in making the S election did not advise about the potential problem with passive income. Priv. Ltr. Rul. 201827010 (Apr. 3, 2018).
Disproportionate Withdrawals Didn’t Create Second Class of S-Corporate Stock. The petitioner and his brother formed an S corporation with the petitioner owning 49 percent of the stock and the brother owning 51 percent. Initially, the petitioner and his brother filed K-1s and returns with each of them reporting their share of S corporate tax items in proportion to their stock interests. But, as time went on, the petitioner’s brother started withdrawing corporate funds for personal use in excess of his proportional interest. The petitioner discovered the brother’s conduct and withdrew from the corporation. The petitioner claimed that he was not responsible for his share of corporate income for the years at issue because his brother’s disproportionate withdrawals created a second class of stock causing the corporation to lose its S status. The court disagreed, noting that there was no evidence that the brother took any steps to redefine shareholders’ rights or create a new class of stock. As a result, the petitioner remained subject to tax on his portion of the S corporate income. Mowry v. Comr., T.C. Memo. 2018-105.
No Minority Shareholder Oppression in Farm Case. This case involved a dispute among family members involved in a farming corporation. The plaintiffs, siblings, sued their parents and another sibling for their share of the business. Between one of the defendant’s divorces and a sibling leaving the farming operation, the stock in the family farm had been re-organized on numerous occasions. In accordance with a 1986 divorce stipulation, all corporate stock was converted to voting stock. However, no corporate documents reflected this change. A 1998 business meeting revealed that each of the shareholders owned 170 shares, but there were no details if there was break down of voting or non-voting shares at this meeting. Contentions within the family farming business (the family was also involved in a bank, bank holding company, and insurance business) had been boiling for decades, but climaxed when dissolution of the farming business was imminent. Starting in 2011, tolling agreements were entered in to. In addition, the defendant sibling offered many times to buy out the plaintiffs. However, the plaintiffs declined. The plaintiffs took their action to Iowa Business Court (a specialty court with judges not subject to public review) claiming that all the stock was voting shares and that the farm should be dissolved due to “minority shareholder oppression.” The business court held that the shares were never all converted to voting shares, and that no minority shareholder oppression occurred. The plaintiffs appealed and the appellate court affirmed. While the plaintiffs pointed to the 1986 separation agreement stating that all the shares were voting shares, the appellate court determined that while the father owned a majority of the shares and made the farm business decisions, the other shareholders never explicitly gave him the authority to change the stock to voting stock as a bargaining chip in the settlement. Thus, this settlement was outside the normal course of the farm business and was unenforceable. In addition, while the articles of incorporation clearly delineated between different shares, and many years of business meeting minutes showed the different stock amounts of each of the shareholders they did not detail the voting rights of the shares. Consequently, the appellate court held that the voting and non-voting status of the shares would be maintained. On the minority shareholder oppression issue, the plaintiffs claimed that a continuing wrong existed that would defeat any statute of limitations argument. In particular, they claimed that the court should consider conduct before 2006 in accordance with the tolling agreement. However, the appellate court disagreed and would only consider post-2006 conduct on the oppression claim. As for oppression, the plaintiffs claimed that the farming operation’s use of cash basis accounting masked much of the profit earned by the farm, and that the defendants were hiding other farm income in home improvements. However, the appellate court noted that cash basis accounting was standard for farming operations and was not oppressive. The plaintiffs also claimed that the farm could have generated more revenue by renting the ground rather than hiring the defendant. However, the appellate court determined that this claim was successfully rebutted by the defendant’s expert witness testimony that the farm had been operated in standard fashion in accordance with sound business practices. The plaintiffs also claimed that the loans assumed by the defendants were not sound. But, a review of the loans showed that the loans were assumed at low interest rates and were within the normal practice of farms. Finally, the plaintiffs claimed that the offers to buy their shares were “low ball” offers that solidified their oppression claim. However, to use this argument, the plaintiffs would have had to offer their shares only to be rejected for a lower price. Thus, the appellate court determined that the shares were never converted to voting shares and there was no evidence of minority shareholder oppression. Van Horn v. R.H. Van Horn Farms, Inc., No. 17-0324, 2018 Iowa App. LEXIS 585 (Iowa Ct. App. Jun. 20, 2018).
LLC Manager’s Failure to Pay Funds To Bank Under Charging Order Was in Bad-Faith. The plaintiffs borrowed money and guaranteed other loans in connection with a real estate development project. The project failed, the loans went into default, and in April of 2010 a bank obtained a $2.4 million judgment against the plaintiffs. To collect its judgment, the bank foreclosed on real property collateral worth about $1.1 million and obtained a charging order against the plaintiffs' one-half economic interest in two California farming limited liability companies (LLCs). When the LLCs made no payments subject to the charging order, the bank foreclosed on the economic interests that the plaintiffs held in the LLCs. At the foreclosure auction, the bank purchased the economic interests for $1.5 million. After the foreclosure, the LLCs sold their real estate, ceased farming, and distributed over $5 million to the bank as the holder of 50 percent of the economic interests in the LLCs. The LLCs then dissolved. The plaintiffs sued the manager of the LLCs who, along with his wife, owned the other half of the LLCs. The plaintiffs alleged a breach of fiduciary duty, arguing that, despite the foreclosure, they retained an interest in their original capital contributions and accumulated capital of the LLC, which they claimed should have been returned to them instead of being included in the $5 million transferred to the bank. The defendants claimed that the plaintiffs had no right to a return of capital and, instead, the bank had a rightful claim to the funds as the holder of one-half of the "economic interests" in the LLCs. The trial court agreed with the defendants, concluding that the plaintiffs retained no rights to a return of capital and, thus, were not damaged by the allegedly wrongful conduct. The appellate court Appeals reviewed the Beverly-Killea Act (Act) which addresses assignments of membership and economic interests. The appellate court construed the Act’s provisions as a whole to mean that “economic interest” includes the right to receive “distributions” and that “distributions” include the transfer of money or property regarded as capital by the LLCs. The appellate court also held that these definitions cannot be altered by the terms of the parties’ LLC agreements. As such, the appellate court determined that the bank, as the holder of the plaintiffs’ economic interest in the LLCs, was entitled to receive distributions of capital. In other words, the appellate court held that plaintiffs’ retained membership interest did not include the right to receive their capital contributions or the capital accumulated in the capital account they held before the foreclosure sale. Therefore, the appellate court agreed with the trial court that the plaintiffs failed to state a cause of action for breach of fiduciary duty based on the defendants’ failure to return the plaintiffs’ original and accumulated capital interest. However, the plaintiffs also argued that the defendants breached their fiduciary duties by failing to make distributions pursuant to the 2010 charging order, which precipitated the Bank’s eventual foreclosure and liquidation of the LLCs. The defendant’s decision not to make distributions under the charging order caused the bank to foreclose on the economic interest of the plaintiffs in the LLCs and in turn caused the LLCs to cease business operations, liquidate their real property, and go out of existence. The appellate court determined that it was reasonable to infer that going out of business and ceasing to exist was not in the best interest of the LLCs and therefore the defendant’s acts and omissions causing this result were not in the best interest of the LLCs. As such, the court concluded that the plaintiffs alleged sufficient facts to show that the defendant’s discretionary decision to make no distributions to the bank under the charging order was not made in good faith and did not serve the best interest of the LLCs or the plaintiffs in their capacity as members. Consequently, the court vacated the trial court’s decision and directed it to enter a new order overruling it’s decision in the defendant’s favor. Garcia v. Garcia, No. F073735, 2018 Cal. App. Unpub. LEXIS 3520 (Cal. Ct. App. May 22, 2018).
S Corporation Land Rents Not Passive; Trust Shareholder Was ESBT. The taxpayer, an S corporation engaged in farming and managing real property had a grantor trust as a shareholder. The taxpayer engaged in four leases involving the farming operation that generated rental income to the taxpayer. The taxpayer sought a ruling on whether the taxpayer’s rental income was passive investment income under I.R.C. §1362(d)(3)(C), and whether the trust would qualify as an electing small business trust (ESBT) under I.R.C. §1361(e). The trust grantor died and the trust beneficiaries were two distributing trusts that are U.S. individuals and two tax-exempt organizations. Each beneficiary received a stepped-up basis under I.R.C. §1014. Three of the leases provide that the taxpayer is a full participant in the farm’s management, and that the tenant could not deviate from the managerial plan without the taxpayer’s approval. The leases were crop-share leases that also split expenses between the taxpayer and the tenant. The fourth lease provided for the tenant’s plowing, land clearing and crop cultivation for a share of the crops. The IRS determined that the taxpayer’s rental income from the leases was not passive investment income under I.R.C. §1362(d)(3)(C), and that the trust qualified as an ESBT because the beneficiaries were qualified beneficiaries and no interest of the trust was acquired by purchase. Priv. Ltr. Rul. 201812003 (Dec. 15, 2017).
Based On Totality of Facts, Corporate Veil Not Pierced. The plaintiff, a trust, was established as a form of estate planning. The trustee used trust assets to purchase a pizza franchise. Later, the trust entered into a written agreement to sell the business to JKLM, Inc., one of the defendants in this case, on contract. The building that the business was located in was sold separately to Dearborn Enterprises, Inc. Kari Dearborn, the other defendant in this case, was the president of JKLM and signed the purchase contract as “Kari Dearborn, president.” The plaintiff did not ask for a personal guarantee from Kari, but did have an attorney prepare and file financing statements against the equipment sold as part of the business. The agreement showed a purchase price of $120,000 and required $15,000 as a down payment. The defendant was incorporated less than a month before the purchase of the business. Statements show the defendant had only $3,000 in assets at the time of the purchase and borrowed the other $12,000 for the down payment from Dearborn Enterprises. During the period the defendant ran the business, loans were made to family members from the corporation. The defendant made monthly payments to the plaintiff for more than two years, but citing the inability to find part-time employees, closed. The plaintiff sued, alleging breach of contract and claiming the corporate veil should be pierced. The trial court determined that the contract was breached. However, the trial court held the plaintiff had not sufficiently proven facts sufficient to pierce the corporate veil. The plaintiff appealed. The plaintiff claimed that the defendant co-mingled its finances with the finances of its shareholders and at least one related entity; failed to follow corporate formalities; and was undercapitalized. The appellate court found that the “loans” the defendant made to shareholders had proper business purposes, such as reducing initial payroll expense, and did not represent co-mingling of assets. In addition, the court acknowledged that a corporation can ratify its prior actions including its corporate formalities. However, at the time the plaintiff incurred the damages caused by the defendant’s breach of contract, no ratification had been completed. The appellate court held that a corporation cannot escape having its corporate veil pierced by ratifying corporate formalities long after the lawsuit has been initiated and damages caused. The appellate court determined that the defendant’s corporate formalities displayed irregularities and did not perfectly follow corporate formalities. However, the appellate court held that the defendant’s actions and those of its officers substantially complied with normal business practices. The appellate court also found that even before purchasing the business, the defendant had four times as much debt as capital. After purchasing the business, the defendant had forty times as much debt as initial contribution. Thus, the court held that the capital contribution was insufficient to consider the defendant properly capitalized. But, even with this fact, the appellate court determined that the plaintiff did not present sufficient evidence to show pierce the corporate veil. According to the appellate court, the balance of evidence showed that the defendant was not operated as a mere shell and existed for a legitimate business purpose. Consequently, the appellate court held upheld the trial court’s determination that the corporate veil should not be pierced. Laddie Nachazel Family Living Trust v. JLKM, Inc., No. 16-2045, 2018 Iowa App. LEXIS 106 (Iowa Ct. App. Feb. 7, 2018).
Homestead Exemption Inapplicable To Corporate-Owned Property. The plaintiff held a lien against a property that the defendant, a corporation, owned. The property was occupied by a third party (the corporation’s president and sole shareholder) that had no individual ownership interest in the property. In 2012, at a time when the property was not occupied, the plaintiff was injured while on the property and sued the defendant for her injuries. In 2014, during the pendency of the litigation, the defendant attempted to quitclaim deed the property to the third party. The deed failed for lack of consideration, lack of corporate seal, lack of evidence of proper corporate capacity or authority for signatures, and the acknowledgement clause signed by the notary was for an individual rather than a corporation. After the attempted transfer, the third party began residing on the property with her family. In late 2015, the trial court awarded the plaintiff almost $400,000 in damages. To collect on the judgment, the plaintiff claimed that the defendant had tried to transfer the property to bar a forced sale of it. The plaintiff sought a constructive trust on the property and injunctive relief that would prevent the defendant from transferring the property. Ultimately, the trial court entered a temporary injunction that prevented the transfer of the property. After a hearing, the trial court determined that the property was protected from a forced sale or transfer to the plaintiff because of its status as a homestead due to the third party’s possession of the property. The appellate court reversed on the basis that the defendant, a corporation, cannot hold a homestead exemption on real estate. The appellate court noted that only a natural person can claim a homestead exemption. Because the attempted transfer of the property to the third party was not successful, the defendant still owned the property. The appellate court distinguished property held in trust where a natural person holds a beneficial interest and can claim a homestead exemption, and the present situation where a natural person did not have any ownership interest in the property, fee simple or otherwise. The court also noted that the third party’s status as sole shareholder and corporate president did not give the third party an interest in the defendant’s property. DeJesus v. A.M.J.R.K. Corporation, No. 2D17-2374, 2018 Fla. App. LEXIS 1843 (Fla. Ct. App. Feb. 9, 2018).
Relief For Partnerships Impacted by Law Change For Return Due Date. The IRS granted relief from late-filing penalties for partnerships (and other entities that may properly file Form 1065) that failed to file their return or extension by the original due date. In the IRS relief, relief was extended to other items (such as funding a contribution to an employee benefit plan by the due date of the return for which a deduction is claimed on the prior year return), except interest on tax due, that were impacted by the change in the law as a result of legislation enacted during the summer of 2015 that changed the due date for partnership returns. Under the legislation, calendar year partnership returns for 2016 became due on March 15, 2017, rather than April 15 as under prior law. In the relief, the IRS noted that a filed Form 1065 will be treated as timely for the first taxable year that began after December 31, 2015, and ended before January 1, 2017, if the entity would have been deemed to timely file under prior law. The IRS also provided instructions for getting reconsideration from IRS of a penalty that had already been assessed. The IRS later revised its guidance such that any act performed by a partnership of other entity that may properly file Form 1065 is deemed to have properly filed if such filing would have been timely under prior law whether the tax year ends in 2016 or 2017. IRS Notice 2017-47, 2017-38 I.R.B. 2017-141, as revised by IRS Notice 2017-71, 2017-51 I.R.B.
Entity-Structured Loss Disallowed For Lack of Economic Substance. The petitioner retired in the same year that his employer sold out. As a result of both of those events, the petitioners had a substantial spike in income for that tax year. Hi tax attorney suggested the formation of an S corporation and a family limited partnership (FLP). The petitioner transferred cash and marketable securities to the S corporation with the S corporation then transferring the assets to the FLP. The result was that the S Corporation would own the FLP and the FLP would hold the petitioner’s cash and marketable securities. The S corporation then dissolved in the same tax year and distributed its FLP interest to the petitioner and other partners upon dissolution. The distributed FLP interest was valued with significant valuation discounts for lack of marketability and minority interest. The result was that a large tax loss was generated upon the S corporation’s dissolution. A revocable management trust was then formed to hold the general partnership interest of the FLP. The petitioner’s tax attorney advised that all of these maneuvers would generate either a capital or ordinary loss deduction because of the business purpose of the S corporation. The IRS denied the loss on the basis that the entire structure that the petitioner implemented lacked economic substance and was implemented solely for the purpose of generating an income tax loss. The Tax Court agreed with the IRS, noting that Fifth Circuit (the Circuit to which the case would be appealed) authority utilized a multi-factor test for determining the existence of economic substance (Klamath Strategic Investor Fund ex rel. St. Croix Ventures v. United States, 568 F.3d 537 (5th Cir. 2009) and that the petitioner’s transactions satisfied none of the tests. Importantly, the court noted that the various entities and structures did not change the “petitioners’ economic position in any way that affected objective economic reality.” The court did not find the taxpayer’s business purpose claim persuasive based on the facts of the case. Smith v. Commissioner, T.C. Memo. 2017-218.
Insufficient S Corp Basis To Deduct Indirect Loan Loss. The petitioners, a married couple, formed an investment advisory firm. They also each owned 40 percent of the outstanding stock of an S corporation. The S corporation subsequently became the 100 percent owner of another business that elected to be a qualified subchapter S subsidiary (QSUB). The QSUB borrowed money from an unrelated third party to finance the acquisition of another business. The petitioners then formed another S corporation that they were the sole owners of. They then used that second S corporation to buy the debt of the QSUB. The petitioners claimed that they could use the QSUB debt that the second S corporation held to increase their tax basis in the first S corporation so that they could deduct losses that passed through to them from the first S corporation. The petitioners claimed that the second S corporation was to be ignored because it was merely acting as an agent or conduit of the petitioners (an incorporated pocketbook of the petitioners). Thus, the petitioners claimed that they had made an actual economic outlay with respect to the acquisition of the QSUB debt to their financial detriment. As such, the petitioners claimed that the second S corporation should be ignored and its debt actually ran directly between the first S corporation and its shareholders, of which they owned (combined) 80 percent. The IRS disallowed the loss deduction due to insufficient basis and the Tax Court agreed. The Tax Court determined that there was no evidence to support the claim that the second S corporation was operating as the petitioners’ incorporated pocketbook. The Tax Court noted that the second S corporation had no purpose other than to acquire the debt of the QSUB, and the petitioners did not use the second S corporation to pay their expenses of the expenses of the first S corporation. There also was no evidence that the second S corporation was the petitioners’ agent because the corporation operated in its own name and for its own account. The Tax Court also held that the petitioners had not made any economic outlay except to the second S corporation. As such, the second S corporation could not be ignored and the petitioners could not use its debt to increase their tax basis. The Tax Court noted that 2014 IRS final regulations and I.R.C. §1366(d)(1)(B) require that shareholder loans must run directly between the S corporation and the shareholder. Messina v. Comr., T.C. Memo. 2017-213.
Management Fees Were Nondeductible Proft Distributions. The petitioners, a married couple, owned two corporations. The corporations paid $12.8 million in management fees to a third company where the husband was the president and the wife was a secretary. The fees nearly depleted the profits of the operating companies, but did generate approximately a $9 million deduction. The management company was established after the petitioners’ attorney (to whom they paid $50,000 for to set up the business structure) attended a presentation that touted ways to reduce corporate income tax liability by setting up a new subchapter S corporation, a deferred compensation plan and an employee stock ownership plan. The IRS disallowed the deduction on the basis that the fees paid were really disguised, nondeductible profit distributions to the petitioners. The Tax Court, agreeing with the IRS noted that the petitioners owned the operating companies and that shareholder executive compensation in a closely-held corporation that depletes the majority of the corporate value is generally unreasonable when it is disguised as nondeductible distribution of profit. The court noted that the husband’s compensation exceeded market rates and was not established in accordance with any arm’s-length standard. The court also noted that the husband was paid the vast majority of the management fee, and while his duties remained constant each year, his compensation (included deferred amounts) ranged from $9.5 million to $685,000 from 2001-2003. The court, without any evidence from the petitioners as to how they computed the amount of the management fees to be paid, determined that the appropriate deduction for reasonable compensation was $3.7 million. The court also noted that the petitioners did not seek outside legal or tax advice separate from their attorney who was part of the “promoter group,” and also rejected their “expert” witness for lack of any experience with the valuation of management contracts or executive compensation. The court upheld penalties for substantial understatement of tax in addition to the IRS-asserted $5 million tax deficiency. Wycoff v. Comr., T.C. Memo. 2017-203.
Rental and Employment Agreements Appropriately Structured; No Self-Employment Tax on Rental Income. The petitioners, a married couple, operated a farm in Texas. In late 1999, they built the first of eight poultry houses to raise broilers under a production contract with a large poultry integrator. The petitioners formed an S corporation in 2004, and set up oral employment agreements with the S corporation based on an appraisal for the farm which guided them as to the cost of their labor and management services. They also pegged their salaries at levels consistent with other growers. The wife provided bookkeeping services and the husband provided labor and management. In 2005, they assigned the balance of their contract to the S corporation. Thus, the corporation became the “grower” under the contract. In 2005, the petitioners entered into a lease agreement with the S corporation. Under the agreement, the petitioners rented their farm to the S corporation, under which the S corporation would pay rent of $1.3 million to the petitioners over a five-year period. The court noted that the rent amount was consistent with other growers under contract with the integrator. The petitioners reported rental income of $259,000 and $271,000 for 2008 and 2009 respectively, and the IRS determined that the amounts were subject to self-employment tax because the petitioners were engaged in an “arrangement” that required their material participation in the production of agricultural commodities on their farm. The Tax Court noted that the IRS agreed that the facts of the case were on all fours with McNamara v. Comr., T.C. Memo. 1999-333 where the Tax Court determined that the rental arrangement and the wife’s employment were to be combined, which meant that the rental income was subject to self-employment tax. However, the Tax Court’s decision in that case was reversed by the Eighth Circuit on appeal. McNamara v. Comr., 236 F.3d 410 (8th Cir. 2000). The Tax Court, in the current case, determined that the Eighth Circuit’s rationale in McNamara was persuasive and that the “derived under an arrangement” language in I.R.C. §1402(a)(1) meant that a nexus had to be present between the rents the petitioners received and the “arrangement” that required their material participation. In other words, there must be a tie between the real property lease agreement and the employment agreement. The court noted the petitioners received rent payments that were consistent with the integrator’s other growers for the use of similar premises. That fact was sufficient to establish that the rental agreement stood on its own as an appropriate measure as a return on the petitioners’ investment in their facilities. Similarly, the employment agreement was appropriately structured as a part of the petitioners’ conduct of a legitimate business. Importantly, the court noted that the IRS failed to brief the nexus issue, relying solely on its non-acquiescence to McNamara (A.O.D. 2003-003, I.R.B. 2003-42 (Oct. 22, 2003)) and relying on the court to broadly interpret “arrangement” to include all contracts related to the S corporation. The Tax Court refused to do so and, accordingly, the court held that the petitioner’s rental income was not subject to self-employment tax. Martin v. Comr., 149 T.C. No. 12 (2017).
Proposed Regulations Eliminate Signature Requirement for I.R.C. §754 Election. Proposed regulations specify that a partnership election under I.R.C. §754 do not need to be signed by a partnership representative. The proposed regulation is designed to deal with the situation of an unsigned I.R.C. §754 election statement with the partnership return (whether filed electronically or in paper) which constituted an invalid I.R.C. §754 election. In those situations, the partnership had to seek relief under the I.R.C. §9100 regulations (automatic relief for errors discovered and corrected within 12 months) or file a private letter ruling request (with payment of fee) seeking relief under Treas. Reg. §302.9200-3. Many private letter ruling requests for relief were submitted and the IRS determined that the removal of the signature requirement would eliminate the need for the IRS to deal with the requests. Accordingly, the IRS determined that removing the signature requirement would eliminate many of the largely identical requests. Under the proposed regulation, a partnership making an I.R.C. §754 election must file a statement with its return that sets forth the name and address of the partnership making the election, and declare that the partnership is electing under I.R.C. §754 to apply the provisions of I.R.C. §§734(b) and 743(b). The proposed regulation can be relied upon immediately upon issuance. REG-116256-17; 82 F.R. 47408-47409 (Oct. 12, 2017).
Valuation Regulations Recommended To Be Withdrawn. The Treasury Secretary has issued a report recommending the elimination of the I.R.C. §2704 Proposed Regulations. While it is possible that the regulations could be reintroduced in the future with revisions, it is not likely that the present version will ultimately be finalized under the current Administration. Second Report to the President on Identifying and Reducing Tax Regulatory Burdens, October 2, 2017.
C Corporate Distributions Taxable. The petitioner was the sole shareholder of a C corporation. The C corporation also made direct payments to the petitioner of $107,500 in 2011 and paid about $5,000 of the petitioner’s personal expenses. In 2012, the C corporation made direct payments of $130,000 to the petitioner and again paid about $5,000 of the petitioner’s personal expenses. The C corporation’s return for 2011 reported that it paid the petitioner $30,000 as compensation, and that amount was also reflected on the petitioner’s individual return. The compensation paid to the petitioner in 2012 was also reported on both the corporate return and the petitioner’s return. For 2012, the corporation reported a net operating loss (NOL). The parties stipulated to many issues, but not certain amounts of the non-compensation direct payments which the petitioner classified as a non-taxable return of capital, but the IRS believed were taxable dividends. The petitioner claimed that the payments in question were intended to be distributions of capital rather be payments from corporate earnings and profits, and were recorded as such on the corporate books. However, the court noted that for 2011 the corporation had sufficient earnings and profits to make the distribution from and the corporation’s intent was irrelevant as was how the corporation treated the distribution on its books. The court also noted that, for 2012, the corporation had sufficient earnings and profits to make the non-compensation distribution in issue. The court noted that under I.R.C. §316(a), a C corporate distribution is made out of earnings and profits if earnings and profits is at least equal to the amount of the distribution. Accordingly, the court upheld the IRS determination including accuracy-related penalties imposed on the corporation. Western Property Restoration, Inc. v. Comr., T.C. Memo. 2017-190.
Farm Equipment Not A Fixture. This case involves a family dispute over farming equipment. Six siblings each had an ownership stake in their family ranch, the CJS Ranch Trust property. The parties sought the dissolution of their joint operations and the CJS Ranch Trust. The parties reached a settlement agreement in which one son assigned his interest in CJR Ranch Trust property and fixtures to his brothers. The settlement also allowed the son to keep all the new farm equipment purchased as shown on the tax returns. In a later decision, the trial court awarded particular equipment to the son and distributed the remaining property. The brothers argue that farm equipment used by CJR ranch constituted fixtures and, as a result, should be retained by them. The trial court determined that the term fixtures did not include any of the farm equipment listed. The brothers appealed. The appellate court determined that the trial court properly defined fixtures and that the items listed did not meet that definition. Moreover, the court determined that most of the items were properly distributed because they were listed on the son’s tax returns. The brothers also claimed that the tria court erred by failing to determine whether JBR Farms was a valid partnership. However, because the trial court did not make any findings on JBR’s partnership and the brothers did not raise the issue at trial they are barred from raising it on appeal. As a result, the court determined that the son should receive the property that was on his tax returns and other equipment awarded to him from the CJR Ranch because the farm equipment did not constitute fixtures of the operation. Scherping v. Scherping, No. A16-1815, 2017 Minn. App. Unpub. LEXIS 581 (Minn. Ct. App. July 3, 2017).
Estate Executor Not Personally Liable For Corporate Debts. A dairy farmer placed ownership interests for the land and business operations of his farm in several corporate entities. He purchased feed on credit through one of these entities, in which he was the owner of 100 percent of the stock. When the farmer died, his son (the defendant) was the sole beneficiary of his estate and exercised control over the farm and its operations as the executor of the estate and as an employee of the entity. The son continued to order feed from the plaintiff, a dairy cattle feed supply company, through the entity. The plaintiff sued to claim the outstanding debts owed by the entity for feed already delivered. The trial court pierced the corporate veil to find that the son was individually liable for the debts incurred by the entity. However, on appeal the state Supreme Court found that the piercing of the corporate veil was improper because the defendant did not possess or exercise ownership interests as a shareholder of the entity. The Court acknowledged that as an executor of his father’s estate the defendant acted as an employee and exercised sole control over the entity. However, the Court determined that this did not transform the defendant’s status into a shareholder or equity holder. Therefore, the Court held that the corporate veil should not be pierced with the result that the defendant was not individually responsible for the entity’s debts. Mark Hershey Farms, Inc. v. Robinson, 2017 Pa. Super. LEXIS 376, No. 1070 MDA 2016, 2017 Pa. Super. LEXIS 376 (Pa. Sup. Ct. May 25, 2017).
No “Oppression” of Minority Shareholder in Farm Corporation. The defendant was incorporated as an S corporation in 1976 by a married couple. The couple had four children – two sons and two daughters. The sons began farming with their parents in the mid-1970s, with one of them becoming corporate president when the father resigned in 1989 and the other son becoming vice-president. Upon incorporation, the parents were the majority shareholders and the sons held the minority interests. The mother died in 2010 and her corporate stock shares passed equally to all four children. In 2012, the father gifted his stock equally to the sons and, after the gift, the sons each owned 42.875 percent of the corporate stock and the daughters each owned 7.125 percent. The father died in early 2014 at a time when the corporate assets included 1,100 acres of irrigated farmland and dry cropland. The corporation, since 1991, leased its land to two other corporations, one owned by one son and his wife, and the other corporation owned by the other son and his wife. The land leases are 50/50 crop share leases with the sons performing all of the farming duties under the leases. In 1993, the corporation converted to a C corporation with corporate employees being paid in-kind commodity wages. For tax planning purposes, corporate net income was kept near $50,000 annually to take advantage of the 15 percent tax rate by timing the purchase of crop inputs, replacing assets and paying in-kind wages. The father and sons did not receive any cash wages, but did receive an amount of commodity wages tied to crop prices and yields – all with an eye to keeping the corporate net income low. Hence, the amount of commodity wages varied widely from year-to-year. The corporation’s CPA testified that he believed the high commodity wages in the later years was appropriate because of the amount of accrued unpaid wages since 1976. The CPA also testified that the corporation was not legally obligated to pay any wages, but that it was merely optional for the corporation to do so. The corporation’s articles of incorporation required a shareholder to offer their shares to the corporation for purchase at book value before selling, giving or transferring them to anyone else. Shortly after her father died, the plaintiff, one of the daughters, offered to sell her shares to the corporation for $240,650 – the fair market value of the shares based on a December 2010 valuation done for purposes of the mother’s estate. The corporation, in return, offered to buy the shares for $47,503.90, the book value as of December 2011 less $6,000 due to a corporate loss sustained by the plaintiff’s failure to return a form to the local Farm Service Agency office. The plaintiff sued in early 2013 seeking an accounting, damages for breach of fiduciary duty and conflicting interests, judicial dissolution of the corporation based on oppressive conduct, misapplication and waste of corporate assets and illegal conduct. The trial court denied all of the plaintiff’s claims, finding specifically that the payment of commodity wages and purchase of expensive farm equipment were not unreasonable or inappropriate.
On appeal, the appellate court affirmed. The appellate court, noting that state (NE) law does provide a remedy to minority shareholders for oppressive conduct, the court stated that the remedy of dissolution and liquidation is so drastic that it can only be invoked with “extreme caution.” The court noted that the plaintiff was essentially challenging the corporation’s tax strategy, and asserting that the corporation should be maximizing its income and paying dividends and the failure to do so constitutes oppressive conduct (the corporation had over $13 million in assets and no debt). The appellate court disagreed, noting that a corporation is not required to pay dividends under state law, and the corporation had a long history in never paying dividends. Furthermore, the appellate court determined that the high level of commodity wages in the later years was not oppressive because it made up for years the shareholders worked without compensation. The court also noted that the plaintiff did not have a reasonable expectation of sharing in corporate profits because the plaintiff never committed capital to the corporation and acquired her stock interest entirely by gift or devise. Furthermore, the court noted that since incorporation in 1976, no minority shareholder had ever been paid profits. The court also held that the payment of commodity wages was not illegal deferred compensation. In addition, the corporation’s offer to pay book value for the plaintiff’s shares was consistent with the corporate articles of incorporation. The plaintiff did not challenge the method by which book value was calculated, and the stock transfer restriction was upheld as enforceable contract. Jones v. McDonald Farms, Inc., 24 Neb. App. 649 (2017).
Business Reorganization Transaction Taxable. Two business partners owned distressed debt loan portfolio companies collectively and created a spinoff nonprofit S corporation to manage an employee stock ownership plan (ESOP). In an I.R.C. §351 transaction, the partners transferred their ownership in the companies to the S corporation in exchange for a combined 95 percent of the S corporation’s common stock with the ESOP owning the remaining five percent. As part of the transaction, the partners entered into a five-year employment agreement specifying that the common stock could be taken back by the S corporation if either of the men were terminated for cause. Based on the agreement, the partners considered the stock as being subject to a substantial risk of forfeiture such that its value would not be included in income under I.R.C. §83(a) which applies when property is transferred to a taxpayer in connection with the performance of services. The amount included is the excess of the FMV of the property over the amount (if any) paid for the property. Consequently, the partners treated the S corporation as the owner of the stock and the all of the income allocated to the S corporation. As a non-profit, the S corporation was tax-exempt. The IRS claimed that the “for cause” provision in the employment agreement made the stock ownership plan substantially vested which meant that the partners were the owners of the stock and subject to tax on the S corporation income. In 2013, the Tax Court held that the stock was subject to a substantial risk of forfeiture. However, the court left open an alternative IRS argument that the partners’ stock was not subject to a substantial risk of forfeiture because the partners were the sole directors which made the forfeiture provisions in the employment agreement not likely to be enforced. The court rejected the IRS argument, but held that after the five-year employment agreement expired, the stock was no longer subject to substantial restrictions and they had taxable income from of almost $46 million. While the court determined that the planning and formation of the ESOP was valid, the court did uphold an accuracy-related penalty for 2004. Austin, et al. v. Comr., T.C. Memo. 2017-69.
No S Corporation Basis Increase for Guarantee of Bank Loans. The petitioner owned a 50 percent interest in an S corporation and personally guaranteed bank loans on behalf of the S corporation. Ultimately, the S corporation defaulted and the bank sued to recover the outstanding balance on the loan and received a judgment which it sought to recover from the petitioner and spouse. The petitioner claimed an S corporation stock basis increase based on the judgments and resulting losses. The IRS disagreed and the court found for the IRS. The court held that the petitioner was not entitled to an increase in stock basis for the unpaid judgments against the petitioner due to her personal guarantees of the defaulted loans. Basis increase was not possible without an economic outlay. Most of the possible penalties did not apply due to reliance on tax counsel. Philllips v. Comr., T.C. Memo. 2017-61.
Members of Member-Managed LLC Have Self-Employment Income on Amounts Exceeding Guaranteed Payment. A group of lawyers structured their law practice as member-managed Professional LLC (PLLC). On the advice of a CPA, they tied each of their guaranteed payments to what reasonable compensation would be for a comparable attorney in the locale with similar experience. They paid self-employment tax on those amounts. However, the Schedule K-1 showed allocable income exceeding the member’s guaranteed payment. Self-employment tax was not paid on the excess amounts. The IRS disagreed with that characterization, asserting self-employment tax on all amounts allocated. The Tax Court agreed with the IRS. Based on the Uniform Limited Partnership Act of 1916, the Revised Limited Partnership Act of 1976 and Mississippi law (the state in which the PLLC operated), the court determined that a limited partner is defined by limited liability and the inability to control the business. The members couldn’t satisfy the second test. Because of the member-managed structure, each member had management power of the PLLC business. In addition, because there was no written operating agreement, the court had no other evidence of a limitation on a member’s management authority. In addition, the evidence showed that the members actually did participate in management by determining their respective distributive shares, borrowing money, making employment-related decisions, supervising non-partner attorneys of the firm and signing checks. The court also noted that to be a limited partnership, there must be at least one general partner and a limited partner, but the facts revealed that all members conducted themselves as general partners with identical rights and responsibilities. In addition, before becoming a PLLC, the law firm was a general partnership. After the change to the PLLC status, their management structure didn’t change. Member-managed LLCs are subject to self-employment tax because all members have management authority. The IRS had also claimed that the attorney trust funds were taxable to the PLLC. The court, however, disagreed because the lawyers were not entitled to the funds. The court didn’t impose penalties on the PLLC because of reliance on an experienced professional for their filing position. Castigliola, et al. v. Comr, T.C. Memo. 2017-62.
Losses Limited By Basis in S Corporation. The petitioner was the sole shareholder of an S corporation. The corporation borrowed $100,000 from a bank before the corporation dissolved. The corporation reported a loss on its Form 1120S and no basis for the petitioner’s stock, and the shareholder also reported it on his personal return. The bank renewed the loan, but listed the now-defunct S corporation as the borrower. The bank also had the petitioner guarantee the loan. The petitioner continued to operate the corporation’s computer business under the old corporate name. The IRS disallowed the loss on the petitioner’s personal return on the grounds that the petitioner didn’t have any tax basis in his S-corporate stock. The petitioner claimed that he did have basis attributable to the personal guarantee of the $100,000 loan on the grounds that the petitioner assumed the balance due on the note as the guarantor and sole obligor which should be treated as a contribution to capital. The court upheld the IRS disallowance of the loss. The mere guarantee of the corporate debt is not enough to generate basis under I.R.C. §1366(d). There must be an economic outlay that, the court said, leaves the shareholder “poorer in a material sense.” This can result, the court noted if the lender looks primarily to the taxpayer to repay the loan, but there was no evidence that the lender looked primarily to the taxpayer to repay the loan. The court believed that the lender was looked to the defunct corporation and the record did not indicate that the petitioner was the party paying the loan. Tinsley v. Comr., T.C. Sum. Op. 2017-9.
Treasury Issues Statement on Proposed I.R.C. §2704 Regulations. In the fall of 2016, the Treasury Department issued proposed regulations involving valuation issues under I.R.C. §2704. Those regulations established serious limitations to valuation discounts, such as minority interest discounts and lack of marketability discounts. In early December of 2016, a public hearing was held concerning the proposed regulations. The proposed regulations were not finalized before President Trump took office, which raises a question as to whether they will ever be finalized. The Treasury Department has now unofficially stated, unbelievably, that the regulations are not intended to do away with minority interest discounts despite what the regulations actually say. The Treasury Department also has stated (unofficially) that the regulations do not require valuations to always be made in conformity with a deemed put right, and that the three-year rule that requires transfers within three years of death will not be retroactive to transfers made before the effective date of when the regulations are finalized (if at all). The Treasury Department has also unofficially stated the if the regulations are finalized, they will not have an effective date before the date of issuance of the final regulations, and for some parts, will not be effective before 30 days after the final regulations are issued. Unofficial statements of Treasury Department Official at Jan. 2017, Miami, Florida, Heckerling Estate Planning Institute.
Accumulated Earnings Tax Applies Even Though Corporation Illiquid. A C corporation was formed by an individual who contributed his interests in eight partnerships to it. One partnership was the manager for all of the other partnership and the individual was one of six board members that managed the management partnership. The individual could not, acting alone, cause the partnerships to distribute cash to the corporation. The partnership agreement required all funds to be retained in the partnership except for those amounts needed to be distributed to any particular partner so that the partner could meet the partner’s federal and state tax liability. The only income that the corporation reported was flow-through income from the partnerships. The C corporation also reported flow-through expenses and a small amount of corporate expenses. The corporation accumulated earnings exceeding $250,000 and the IRS asserted that the accumulated earnings tax should apply. The individual claimed it should not, particularly because the corporation did not even have enough funds to pay a dividend and had no way to force the partnerships to distribute funds to the corporation which would provide the funds to pay a dividend. The individual claimed that the corporation was formed to avoid potential taxation by various tax jurisdictions where the partnerships were located. Thus, the corporation was merely a holding company that didn’t conduct any business of its own besides holding the partnership interests. The IRS noted that under I.R.C. §535(b), the fact that any corporation is merely a holding or investment company is prima facie evidence of the purpose to avoid the income tax with respect to the shareholders. The IRS also noted that the accumulated earnings tax does not depend on the amount of cash available for distribution. The tax is based on accumulated taxable income and is not based on the liquid assets of the corporation. The IRS also noted that I.R.C. §565 contained consent dividend procedures that the corporation could use to allow the payment of a deemed dividend even though the corporation was illiquid. Thus, the IRS concluded that the accumulated earnings tax applied. C.C.A. 201653017 (Sept. 8, 2016).
No Discounts on FLP Interests and No Exclusion From Estate. The decedent was in his upper 90s at the time of his death. He had never married and had no children, but he did have four sisters. The decedent had been the CFA of Abbott Lab and had acquired stock options from the company, starting exercising them in 1962 and had accumulated a great deal of Abbott stock. He formed a trust in 1999 and put 800,000 shares of Abbott stock into the trust. He amended the trust in 2001 and again in 2002. Ultimately, the decedent created another trust, and irrevocable trust, and it eventually ended up owning a limited partnership. Within three years of his death, the decedent made substantial gifts to family members from his living trust. Significant gifts were also made to the partnership. The IRS claimed that the value of the assets that the decedent transferred via the trust were includable in the value of his gross estate under I.R.C. §2036(a). The estate claimed that the transfers to the partnership were designed to keep the Abbott stock in a block and keep his investment portfolio intact, and wanted to transition a family member into managing his assets. The IRS claimed that the sole purpose of the transfers to the partnership were to generate transfer tax savings. The partnership agreement contained a list of the purposes the decedent wanted to accomplish by forming the partnership. None of the decedent’s stated reasons for the transfers were in the list. The court determined that the facts did not support the decedent’s claims and the transfers were properly included in his estate. The decedent also continued to use assets that he transferred to the partnership and did not retain sufficient assets outside of the partnership to pay his anticipated financial obligations. On the valuation issue, the court disallowed valuation discounts because the partnership held assets in a restricted management account where distributions of principal were prohibited. Estate of Beyer v. Comr., T.C. Memo. 2016-183.
Self-Employment Tax Not Limited to Guaranteed Payments Received By LLC Member-Partner. The taxpayer was a member of an LLC taxed as a partnership. The partnership operated restaurants as a franchisee and the taxpayer was paid a guaranteed payment for his services on which he paid self-employment tax. The taxpayer also received flow-through income from the partnership on which he did not pay self-employment tax. The taxpayer was the partnership’s operating manager, president and CEO. The IRS sought advice from the IRS National Office as to whether the taxpayer’s flow-through income was subject to self-employment tax. The taxpayer claimed that the pass-through income was a return on his invested capital and that he had the status of a limited partner under I.R.C. §1402(a)(13) with respect to his distributive share. The National Office of IRS disagreed, noting that the taxpayer actively participated in the partnership’s operations and performed extensive executive and operational management services for the partnership in his capacity as a partner. The LLC had only one class of interest. The National Office of IRS also concluded that there is no “reasonable compensation” limitation on self-employment income for partners in a partnership. The advice from the National Office did not discuss that the taxpayer's desired outcome could have been achieved had the entity been structured as a manager-managed LLC. That structure, in accordance with Prop. Treas. Reg. Sec. 1.1402(a)-2(h)(2), allows treatment as a limited partner with no self-employment tax on non-guaranteed payments that represent returns on capital invested if there are two classes of membership and the managing partner’s share of partnership income is bifurcated between managing class and investor class interests. C.C.A. 201640014 (Jun. 15, 2016).
A minority shareholder holding 26.29 percent interest in a family farming corporation wanted the corporation to buy-out his interest. He never invoked a 1984 buy-out provision that was adopted at his request, but demanded that his interest be bought out at a price he deemed acceptable. The majority shareholders attempted to negotiate with the minority shareholder in good faith, but the parties couldn’t agree on the “process” for valuing the shares that the minority shareholder could agree to before he sued for “oppression.” While the minority shareholder never established that the majority breached any fiduciary duties with respect to the shareholder, and the corporation was operated in an efficient manner that dramatically increased its value (and, hence, the value of the minority shareholder’s stock interest), the minority shareholder claimed that the majority undervalued his interest by taking into account a minority interest discount and never paying him a dividend. That, the minority shareholder claimed, constituted oppression, and he sued seeking an order that either the corporation be dissolved or that his shares be bought-out at fair market value – which he claimed to be $1,825,000 without reflecting any discount for minority interest or the tax cost the corporation would incur by liquidating to pay his buy-out price.
So, what can a minority shareholder reasonably expect? Here are the reasonable expectations of a minority shareholder in a closely-held farming operation are: (1) that the corporation will likely never pay a dividend; (2) that the minority shareholder will not be able to participate in management; and (3) that the value of the minority shareholder’s interest will be discounted on buy-out to reflect the fact that it is a minority interest and that the buy-out price will also include a discount to reflect the tax imposed on the corporation due to the buy-out of the minority shareholder. Importantly, under the Baur facts, the minority shareholder received his entire stock interest in the corporation by gift and inheritance, and never worked in the farming business. As such, he hadn’t committed any capital to the family farming operation and “the sole source of his equity was the result of the investment of others and corporate retained earnings which were the result of others in profitably running the farming operation.” The trial court’s remand decision was detailed on all of these points, with the trial court first pointing out that the Iowa Supreme Court “did not determine whether Jack’s [the minority shareholder] articulated expectations in the present case were reasonable.” That’s a key point - there cannot be a violation of a minority shareholder’s reasonable expectations if the minority shareholder didn’t have reasonable expectations!
• The court noted that expectations are only reasonable if they are made known to the other shareholders and that Jack could not reasonably expect to redeem his shares for a price that did not take into account the bylaw restrictions (which he drafted), the expectations of the other shareholders, and the impact of redemption of his interest on the corporation and the other shareholders. On this point, the trial court noted that Jack never announced his expectation to redeem his stock for more than what would be calculated under the bylaws until many years after the bylaws were adopted, and that he had no reasonable expectation that a different methodology would be used. Other shareholders, the trial court noted, would not have supported the 1984 bylaw amendment had they known of Jack’s expectation.
• On the issue of redemption of Jack’s shares without regard to the impact on the corporation or the rights of other shareholders, the trial court determined that the other shareholders would have every right to be treated the same as Jack upon redemption of their shares, and that Jack’s contrary expectations were not concurred in by the other shareholders and were not reasonable.
• On the fact that the corporation didn’t pay dividends, the trial court noted that Jack admitted that he never requested that the corporation pay dividends and that he acknowledged that it is not a good idea for farm corporations like Baur Farms, Inc., to pay dividends.
• The trial court noted that Jack made no capital investment in the corporation at any time and that his redemption rights are subject to the 1984 bylaws.
• On the negotiations surrounding an attempted buy-out, the trial court noted that the parties never reached an impasse due to the majority shareholders insisting on a minority discount for Jack’s shares. In addition, the trial court noted that buying Jack out at the amounts he identified in the 1992-1996 negotiations or in his 2007 offer, would have been oppressive to the other shareholders. In addition, the trial court noted that the corporation’s last offer did not include a minority interest discount and was substantially more than the liquidated value of Jack’s stock based on market value figures.
• The trial court also determined that the corporation’s insistence on a discount for built-in gains on liquidation (unreduced to present value) was not unreasonable. On this point, the trial court found the corporation’s expert witness testimony to be persuasive. That testimony focused on the taxes that the corporation would have to pay if it liquidated. The trial court noted that Jack repeatedly sought liquidation of the corporation at corporate board meetings (he was a board member), and that if the corporation were to be liquidated (the statutory remedy if Jack were to establish oppression) he would receive net liquidation value – which would reflect the after-tax value of his interest.
• The trial court held that the fair value of Jack’s shares under the Iowa Supreme Court’s standard did not exceed the amount of his proportionate share of the market value of the corporation’s assets, discounted to liquidation value, and that the $430,000 final offer the corporation made in 1996 was based on the fair market value of the corporation’s assets and exceeded Jack’s proportionate share of the corporation’s liquidated value at that time.
• The trial court concluded that Jack made demands that exceeded the fair value of his equity interest in the corporation. Accordingly, Jack failed to prove oppression by a preponderance of the evidence, and that the fair value of Jack’s shares was the market value of the corporate assets, discounted for their liquidation value. The trial court also noted that the corporation did not have the resources to pay Jack’s buy-out demand price and that his demand price exceeded the fair value of his equity interest in the corporation. While no minority discount was allowed (pursuant to Iowa law), the court dismissed Jack’s action for dissolution.
Observation. Clearly, the trial court’s remand decision was welcome relief for closely-held corporations in Iowa from an Iowa Supreme Court decision that is out-of-step with reality. To find, as the Iowa Supreme Court did, that there can be shareholder oppression (with the likely result of corporate liquidation) where there isn’t even an allegation of a breach of fiduciary duties by the controlling shareholders would result in, as the trial court’s remand decision points out, oppression of the majority and could also result in corporate liquidation anytime a minority shareholder wants to “cash-out” for personal gain (as in the present case). The trial court’s decision also upholds the use of bylaws that set forth stock valuation upon buy-out. In this case, the Iowa Supreme Court allowed the minority shareholder to ignore the bylaw setting forth the valuation methodology for a buy-out (which he drafted), but the trial court held him to it. That’s more welcome news for closely-held corporations.
The minority shareholder sought review of the trial court’s remand decision, and the case was argued before the Iowa Court of Appeals on June 15, 2016. The panel of judges hearing the case consisted of Vogel, Doyel and Bower, with judge Bower asking most of the questions. In recent months, judge Bower had authored two opinions involving closely-held corporations in which he did not find oppression of a minority shareholder.
The Iowa Court of Appeals issued its decision on July 27, 2015, and affirmed the trial court’s holding that the minority shareholder had not been oppressed. The appellate court determined that the trial court properly considered whether the corporation had the financial resources to buy Jack’s shares at his requested price. It did not. The appellate court also agreed with the trial court’s conclusion that Iowa law did not allow a minority interest discount. The appellate court also found that the trial court properly weighed the evidence concerning the impact of a built-in gain tax on the corporation in the event it was liquidated to pay-off Jack’s interest. The corporation’s expert witness testimony on that point was, the court said, “reasonable and persuasive’ particularly in light of the fact that Jack had made repeated motions at board meetings for corporate dissolution. As such, “market value” of Jack’s interest is the value reflecting the impact of the built-in-gain tax on the corporation. Accordingly, the minority shareholder was not oppressed by the corporation not accepting Jack’s offer to buy him out at $1,825,000.
The case is Baur v. Baur Farms, Inc., No. 14-1412, 2016 Iowa App. LEXIS 726 (Iowa Ct. App. Jul. 27, 2016).
North Dakota Corporate Farming Law Not Modified. Historically, a North Dakota corporation could own farmland if it had 15 or fewer persons as shareholders. However, in 2015, S.B. 2351 was signed into law that would allow the ownership or leasing of land used for a dairy farm or swine production facility by a domestic corporation or an LLC on up to 640 acres where the dairy operation became operational within three years of the date of the land acquisition and the dairy farm is permitted as an animal feeding operation or as a concentrated animal feeding operation by the state department of health and consists of at least 50 cows or at least 500 swine. (N.D. Cent. Code §10-06.1-12.1). The law was to go into effect on August 1, 2015, but the effectiveness of the law change was delayed until after a vote on a referendum concerning the new law set for June 14, 2016. At the referendum vote, ND voters rejected the bill by a 75.7 percent to a 24.3 percent vote. On a related note, a lawsuit has been filed challenging the existing corporate farming law as unconstitutionally discriminatory.
LLC Operating Agreement Controls Exit of Minority Owner. Three siblings inherited their parents’ property equally. They created an LLC with the inherited property to hold various investments that they would engage in. The defendant, the brother of the two plaintiff sisters, held back $80,000 of his inheritance and invested the balance in the LLC, while the sisters fully invested their inheritances in the LLC. As a result, the sisters each had a 36.46 percent ownership interest in the LLC and the defendant had a 27.08 percent ownership interest. The brother became dissatisfied with the performance of LLC investments and expressed his desire to get out of the LLC, but didn’t formally seek to be terminate his association with the LLC in accordance with the LLC operating agreement. The brother did offer to sell his interest in the LLC to the LLC in exchange for 99 acres of land and would provide the LLC cash or a note for the difference in value between his interest and the value of the land. The sisters viewed his communications (emails) as an intent to withdraw that triggered the operation agreement which tied the purchase price of the brother’s interest to the value of his capital account, which at the time was zero. Alternatively, the sisters offered to pay him $150,000 for his LLC interest in lieu of the buyout terms of the operating agreement. The brother rejected the $150,000 offer as too low, and the sisters sued claiming that he had withdrawn from the LLC and should be compelled to transfer his LLC interest to them. The brother claimed that his communications did not amount to notice of intent to withdraw per the LLC operating agreement, and that the sisters therefore, had no right to his LLC interest. He also claimed unconscionability and sought dissolution of the LLC. The trial court ruled for the sisters on all claims. On review, the court determined that the brother had not given notice of intent to withdraw but was merely negotiating over the selling price of his interest and that the operating agreement did allow for a sale of an LLC interest different than the capital account value. Thus, the sisters were not entitled to specific performance of the operating agreement that would permit them to obtain his interest for no consideration and, as a result, the court did not need to rule on the brother’s claim that the operating agreement was unconscionable. The court also denied the brother’s claim that the LLC should be dissolved because of the sisters’ “oppressive” conduct. While the court noted that the brother had made several attempts to sell his interest in the LLC, he did not make any specific offer for the sisters to consider until he final offered to sell his interest for the 99 acres. Morse v. Rosendahl., No. 15-0912, 2016 Iowa App. LXIS 625 (Iowa Ct. App. Jun. 15, 2016).
Valuation of Timber Farming Partnership At Issue. The decedent's estate held a 41.128 percent limited partner interest in a partnership that was involved in forestry operations. The Tax Court weighted at 75 percent the partnership value of $52 million as determined by a cash flow method (going concern) and assigned a 25 percent weight via the asset value method. There was no evidence that any sale or liquidation was anticipated. The result was that the estate's interest was valued at 27.45 million rather than the $13 million amount that the estate valued the interest at or the $33.5 million value that the IRS came up with. The Tax Court, as to the cash flow value, allowed a lack of marketability discount and added factored in a reduced premium for the partnership’s unique risk. The Tax Court did not impose any accuracy-related penalty. On appeal, the appellate court reversed as to the 25 percent valuation weight and remanded the case to the Tax Court for a recalculation of the value of the decedent's interest based on the partnership being valued as a going concern. The appellate court stated that the Tax Court had engaged in "imaginary scenarios" and on remand the Tax Court was also to more fully explain its decision to reduce the premium. The Tax Court’s remand decision concluded that the going-concern value was the same value as the present value of the cashflows that the partnership would receive. As such, the court gave no weight to the partnership assets. But, because of transfer limitations in the partnership agreement and the general partners wanting to continue the business, it was not likely that an entity would be able to diversity its by buying the partnership interest. Thus, a buyer would likely demand a premium for the unique risk of the partnership. So, the court valued the decedent’s interest as a going concern with the application of a premium for the partnership. Estate of Giustina v. Comr., T.C. Memo. 2016-114, on remand from, 586 F. Appx. 417 (9th Cir. 2014), rev'g. in part, T.C. Memo. 2011-141.
LLC Operating Agreement Language Voided. In this bankruptcy case, the debtor was an LLC that filed for Chapter 11 relief. A secured creditor moved to dismiss the Chapter 11 case on the grounds that the filing was unauthorized because, before the filing, the debtor defaulted on a loan from the creditor and issued the creditor a common equity unit in the debtor and also amended its operating agreement to require the unanimous consent of all equity unit holders as a precondition to any voluntary bankruptcy filing. The court, however, denied the creditor’s motion to dismiss on the basis that the unanimous consent provision in the amended LLC agreement amounted to an unenforceable contractual waiver of the debtor of the right to file for bankruptcy. The court noted the public policy of assuring debtors the right to seek bankruptcy relief under the Constitution, and that the policy applied equally to corporations and other business entities such as LLCs. The court also noted that the amended LLC operating agreement had the effect of putting into the hands of a single minority equity holder (in reality a creditor) the ability to eliminate the right of the debtor to file bankruptcy and that even if doing so were permissible under state law, the provision violated public policy. In re Intervention Energy Holdings, LLC, et al., No. 16-11247 (KJC), 2016 Bankr. LEXIS 2241 (Bankr. D. Del. Jun. 3, 2016).
Corporate Bonus Payment Deemed to Be Reasonable Compensation. The plaintiff was a residential concrete construction business that had been formed in 1974 with most of the daily operation of the business transitioned to two of the founder’s sons. The founder’s wife owned 51 percent of the plaintiff’s stock and the two sons owned the balance. In the early 2000s, the plaintiff’s revenue increased substantially – going from $24 million in 2003 to $38 million in 2004. For those years (the years under audit) the sons earned (combined) $4 million in 2003 and $7.3 million in 2004 (salary plus bonus as a percentage of sales). The company also had a practice of paying dividends. For 2003 and 2004, net income went from $388,000 to $348,600. The IRS asserted that the compensation was excessive for 2003 and 2004, but the Tax Court disagreed. The court noted that the sons worked over 60 hours a week and were in charge of the two divisions, and that the IRS conceded that it was difficult to find similar companies with similar profits. The court also noted that the compensation had been paid consistent with the bonus plan. The court also allowed a $500,000 payment to an affiliated company despite the fact that there was no written contract and it was recorded as an administrative expense on the tax return. The court also rejected the IRS argument that an independent investor would require a greater return on equity. H.W. Johnson, Inc. v. Comr., T.C. Memo. 2016-95.
No Breach of Fiduciary Duty and No Right of Dissociation in Family Partnership. A mother and her two sons formed a family limited partnership (FLP) in 2002. The two sons each owned a 45.8 percent interest (paying nothing for their interests) in the FLP and the mother owned 8.4 percent. The mother was the general partner and was responsible for managing the partnership, and her sons were the limited partners with no significant duties. The FLP contained over 2,000 acres and the sons jointly farmed the land until 2006, when the each started separate cattle and farming operations. In early 2007, the FLP loaned one of the sons $350,000 and leased the FLP land to him. The other brother sued his mother and brother claiming that his mother breached fiduciary duties along with other claims including slander, negligence, fraud, deceit, an accounting and valuation of the limited partnership and judicial dissolution of the partnership. The trial court jury determined that the mother did not breach any fiduciary duties by making the loan and leasing the property to the other brother. The FLP then renewed the lease and entered into a contract for deed to sell 830 acres of the leased property to the tenant-son for the appraised price of $1,100,000. The plaintiff son filed a new suit pleading multiple causes of action including a renewed claim that his mother breached her fiduciary duty to the FLP and froze him out of the partnership and caused him to incur tax liabilities without receiving any partnership distributions to pay the tax. The plaintiff son also sought dissociation from the partnership for value. The jury ruled against the son on the breach of fiduciary duties claim and dismissed the other claims. The court also denied the dissociation for value claim. On appeal, the appellate court affirmed. The court noted that the son failed to show that he had any duties that he was incapable of performing (a statutory requirement for dissociation), being admittedly a passive investor in the FLP. The court also held that the son was not entitled to dissociation based on equity because dissociation based on equity was not allowed by statute. Gibson v. Gibson Family Limited Partnership, et al., No. 27476, 2016 S.D. LEXIS 48 (S.D. Sup. Ct. Mar. 23, 2016).
Boilerplate FLP Language Contributed To Implied Retained Interest That Defeated Estate Tax Savings. The decedent’s predeceased husband established trusts and a family limited partnership (FLP). The FLP agreement stated that, “To the extent that the General Partner determines that the Partnership has sufficient funds in excess of its current operating needs to make distributions to the Partners, periodic distributions of Distributable Cash shall be made to the partners on a regular basis according to their respective Partnership Interests.” The decedent, who was living in a nursing home at the time the FLP was formed, contributed approximately $6 million of marketable securities to the FLP and held a 99.9 percent limited partner interest. Before death, the decedent received one check from the FLP (a pro-rata distribution of $35,000). At trial, the General Partner testified that he believed that the FLP language was merely boilerplate and that distributions weren’t made because “no one needed a distribution.” The court viewed the FLP language and the General Partner’s testimony as indicating that the decedent retained an implied right to the possession or enjoyment of the right to income from the property she had transferred to the FLP. The decedent also retained a large amount of valuable assets personally, thus defeating the General Partners’ arguments that distributions were not made to prevent theft and caregiver abuse. The court also noted that the FLP was not necessary for the stated purposes to protect the surviving spouse from others and for centralized management because trusts would have accomplished the same result. The decedent was also not involved in the decision whether to form an FLP or some other structure, indicating that she didn’t really express any desire to insure family assets remained in the family. The court also noted that there was no meaningful bargaining involved in establishing the FLP, with the family simply acquiescing to what the attorney suggested. The FLP also ignored the FLP agreement – no books and records were maintained, and no formal meetings were maintained. As such, the court determined that there was no non-tax purpose for the formation of the FLP, there was no bona fide sale of assets to the FLP and the decedent had retained an implied right to income from the FLP assets for life under I.R.C. §2036(c) causing inclusion of the FLP assets in the decedent’s estate. Estate of Holliday v. Comr., T.C. Memo. 2016-51.
Poor Planning Leads to Rough Farm Transition. A son had farmed with his father for 25 years until the father's death. The father's will bequeathed one-half of the farm personal property to the son with the other half passing to the son's three non-farm siblings. The will also left the farmland to the four children equally with the son having a right of first refusal with respect to any sale of the farmland. The son filed a claim in the probate estate that he was entitled to all of the farmland based on an oral promise from his parents and that he had detrimentally relied on that promise. The trial court denied the claim and the son appealed. On appeal, the court affirmed on the basis that the evidence failed to establish a clear and definite promise that the son would receive the farmland without paying for it. The court also held that the evidence failed to support the son's claim that he was entitled to be reimbursed for funds he spent on machinery and buildings over the prior 25 years. In re Estate of Beitz, 886 N.W.2d 202 (Iowa Ct. App. 2015).
Former Partner Not Entitled To Partnership Accounting. This case involved a family farm partnership that formed between two sisters and their spouses after the sisters' father retired from farming. Bayer Crop Science (BCS) planted GMO rice in an area near the partnership's farming operation which spread into other rice operations and caused the price of rice to drop. The plaintiff, one of the partners, did not want to participate in the class action lawsuit being brought against BCS, but one of the other partners did meet with one of the lawyers bringing suit against BCS who then hired the lawyer to represent the partnership in the suit against BCS. The plaintiff was notified of the meeting, but did not attend. Over the following several years these two partners did not speak with each other, but all correspondence concerning the BCS litigation was left on the partnership's office desk and the plaintiff would always go through the mail and none of the 19 letters received from BCS were ever hidden or not disclosed. The plaintiff then decided to retire for health reasons and wanted to liquidate the partnership. However, the other partners wanted to continue the business. Consequently, the partners entered into a buy-sell agreement on December 17, 2010 whereby the plaintiff would convey his interest back to the partnership for $825,000 and some land. The agreement did not mention the BCS pending litigation. Three days after the buy-sell agreement was executed, BCS sent a letter to the partnership that it was settling the litigation and that the partnership would receive $310/acre. The letter was placed in the open on the partnership office desk with the rest of the mail. The plaintiff received $825,000 and some land for his partnership interest on Jan. 31, 2011, and he and his wife resigned that day. In July of 2011, the plaintiff's wife learned of the settlement and sought a portion of the $177,000 payment the partnership received from BCS. The partnership refused to pay any amount to the plaintiff or his wife. The plaintiff sued for an accounting under Mo. Rev. Stat. §358.220 and winding up of partnership business, damages for breach of fiduciary duty, failure to disclose the BCS litigation, rescission of the buy-sell agreement based on mutual mistake and unilateral mistake and punitive damages. The trial court ruled for the defendant on all points. On appeal, the court affirmed. The plaintiff was fully informed of the BCS litigation and chose not to participate in it, and lied about not knowing about it. The court also held that the plaintiff was not entitled to an accounting because the plaintiff was a former partner who had sold his partnership interest. The court noted that the buy-sell agreement specifically stated that any assets not mentioned in the agreement were transferred with the partnership interest, and the agreement contemplated that any unidentified assets would be transferred to the remaining partners. Mick v. Mays, 459 S.W.3d 924 (Mo. Ct. App. 2015).
Majority Shareholders Did Not Breach Fiduciary Duties and Minority Shareholder Had Unreasonable Expectations. A family S corporation was created in 1983 with family members holding the corporate stock. A nephew of the founder, the plaintiff, bought a 25 percent interest in the corporation in 1993 and was being groomed as the founder's successor. However, the founder ultimately decided that the succession plan wouldn't work with the plaintiff and the plaintiff's employment was terminated in 1995. In 1996, more stock was sold to other family members on the same terms of the 1993 stock sale to the plaintiff and other shares were given to family members. The plaintiff retained his shares and typically sent a representative to shareholder meetings. In 1998, the founder gifted and sold more shares to other family member and then died in 1998 with management transition passing to other family members. The plaintiff still owned 25 percent of the corporation at this time. In 2008, the board sold the remaining share of treasury stock to key employees which had the effect of reduced the plaintiffs overall stock ownership percentage. The plaintiff protested the sale of the treasury stock and bonuses paid to key employees and wanted dividends to be paid to him along with a portion of retained earnings, and wanted paid for two years of employment. The plaintiff ultimately sold the bulk of his stock to pay his own debts. The plaintiff then sued the corporation and the controlling shareholders for breach of fiduciary duty, oppression and unjust enrichment. The trial court dismissed the case and assessed court costs to the plaintiff. The appellate court affirmed. The court noted that frustrated expectations is the plight of all minority shareholders and create no special duty on the part of the majority that could lead to a breach of a fiduciary duty, and the majority's actions were fair to the corporation, which is where fiduciary duties are owed. On the oppression claim, the court cited the IA Supreme Court's Baur opinion (832 N.W.2d 663 (Iowa 2013)) which was, in essence, vacated on remand by the trial court for the Supreme Court's incorrect recitation of the facts of the case (the trial court, on remand, held that the Supreme Court opinion was no longer the law of the case), where the court adopted a reasonableness standard (reasonable expectation of the minority) for handling oppression claims. The court held that there was no oppressive conduct because the bonuses were reasonable and based on expert analysis, and that the plaintiff had no reasonable expectation for employment. The court also rejected the plaintiff's claim of unjust enrichment because there was no breach of a fiduciary duty owned to the plaintiff. Ahrens v. Ahrens Agricultural Industries Co., 867 N.W.2d 195 (Iowa Ct. App. 2015).
Non-Compete Agreement Inapplicable to Former LLC Member. In 2000, a group of doctors formed an LLC to provide diagnostic testing services to patients in two counties. They had a post-withdrawal non-compete agreement prepared that included a provision protecting member investments by restricting competition of former members in the two counties in which the LLC operated. The provision specified that "each member shall...refrain from competing with the Company" within the two designated counties. About five years later, one of the doctors began constructing a sleep laboratory and was going to operate it in the designated counties. The LLC informed the doctor that such operation would violate the LLC agreement, so he withdrew from the LLC and operated the sleep lab. The LLC sued the doctor for breach of the non-compete agreement. The trial court ruled for the former member, holding that the agreement only applied to current or active members. On appeal, the court affirmed, holding that the agreement no longer applied to a former member. Key to the court’s holding was that it determined that the court could only consider extrinsic evidence involving the issue of the ambiguity of a contract that was related to the circumstances under which the agreement was made. The court also held that the withdrawn doctor did not breach any implied duty of good faith and fair dealing and that the LLC had foregone any breach of fiduciary duty claim. Grants Pass Imaging & Diagnostic Center, LLC, et al. v. Machini, 270 Or. App. 127 (2015).
Corporate Veil Pierced - Majority Shareholders Liable For Unpaid Employment Tax. In this case, the court held that the majority owners of a corporation were personally liable for the unpaid employment taxes of the corporation. The court noted that under state (CA) the corporate veil is pierced if the creditor establishes the existence of unity of interest and ownership between the owners and the corporation such that the separate personalities of the corporation and the individual no longer exist, and that if the corporate acts are treated as those of the corporation alone, an inequitable result would follow. The Court, upholding a trial court decision, noted that the majority shareholders exercised substantial control over the corporation's operations, and regularly drew on corporate funds to finance personal expenses. The majority shareholder also borrowed corporate funds without proper documentation. In addition, the majority shareholders facilitated the transfer of funds between the corporation and another corporation where there was a unity of interest and ownership. As such, the majority shareholders were the corporation's alter egos and the corporate veil was pierced resulting in the shareholders being personally liable for the corporation's unpaid employment tax. Politte v. United States, No. 12-55927, 2015 U.S. App. LEXIS 2380 (9th Cir. Feb. 17, 2015), cert. den., 2015 U.S. LEXIS 7073 (U.S. Sup. Ct. Nov. 9, 2015).

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