Opinion ID: 775137
Heading Depth: 2
Heading Rank: 2

Heading: Corporate Reorganization

Text: 7 In 1992, UDF consisted of the parent company, United Dairy Farmers, Inc., and ten subsidiaries. The Lindner family owned UDF. Robert Lindner, Sr., owned approximately sixty percent of the company, and his four sons owned, directly or indirectly, the remaining forty percent. UDF was a Ccorporation, the earnings of which are subject to corporate income tax. A corporation that has elected S corporation status is not subject to an income tax, but rather is considered, for tax purposes, to be a pass-through entity. 8 In 1992, UDF decided to change its corporate form from a C corporation to an S corporation. During this time, UDF made additional changes to its organizational structure. In June of 1992, Robert Lindner, Sr., sold 38% of the outstanding shares in UDF to his four sons and to trusts set up for his grandchildren. In October of 1992, UDF created a new Scorporation, called Uncle Bud's Fried Dough, Inc. 9 On December 31, 1992, UDF and its ten subsidiaries were merged into Uncle Bud's, which then changed its name to United Dairy Farmers, Inc. The post-merger UDF had the same stock ownership, officers and directors as the pre-merger UDF. The pre-merger UDF, along with its ten subsidiaries, ceased to exist as part of the merger. 10 In a sworn statement describing the merger, a UDF official provided that [t]he purpose of the merger was to simplify the corporate structure of United Dairy Farmers, Inc., and affiliated companies. The merger was also consummated in order to permit the making of an S election under Section 1362(a). (J.A. at 330.) 11 In January of 1993, Robert Lindner, Sr. sold his remaining interest in UDF to his sons. At the conclusion of the June and January sales, each of the four sons controlled 25% of the outstanding shares of UDF, either directly or as trustees. 12 The Code imposes a last-in-first-out (LIFO) recapture tax on C corporations that make an S corporation election. I.R.C. § 1363(d). When a C corporation makes an S corporation election, the C corporation files a final tax return. The LIFO recapture tax seeks to ensure that a C corporation does not underestimate the actual value of its inventory when filing its final return, by calculating the difference between the value of a C corporation's inventory under a last-in-first-out method and a first-in-first-out method. 13 The accounting firm of Ernst & Young advised UDF that it was subject to a significant LIFO recapture tax if it made an S corporation election, which could be avoided by way of a merger. To avoid the tax, UDF created a shell corporation, Uncle Bud's Fried Dough, Inc., which had no operations or inventory. UDF and its subsidiaries then merged into Uncle Bud's, emerging as a single S corporation and changing its name to United Dairy Farmers, Inc. UDF believed that it had avoided triggering the recapture tax because Uncle Bud's, rather than the pre-merger UDF, made the S corporation election. 14 On its 1993 tax return, UDF claimed that payments made to Ernst & Young in 1992 and 1993 totaling $46,300 were deductible as ordinary and necessary business expenses. On audit, the IRS found that the payments were part of a corporate reorganization and must be capitalized, which the district court affirmed.