142 T.C. 317 (T.C. 2014), 10882-10, Swords v. Commissioner of Internal Revenue

Docket Nº:10882-10, 10883-10, 10884-10, 10885-10
Citation:142 T.C. 317
Opinion Judge:MARVEL, Judge:
Party Name:JULIA R. SWORDS TRUST, TRANSFEREE, MARGARET R. MACKELL, DOROTHY R. BROTHERTON, AND JULIA R. SWORDS, CO-TRUSTEES, ET AL.,[1] Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Attorney:Timothy L. Jacobs and William Lee S. Rowe, for petitioners. Randall L. Eager, Jr., Timothy B. Heavner, Matthew S. Reddington, James R. Rich, Kristina L. Rico, and Johnny C. Young, for respondent.
Case Date:May 29, 2014
Court:United States Tax Court
 
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142 T.C. 317 (T.C. 2014)

JULIA R. SWORDS TRUST, TRANSFEREE, MARGARET R. MACKELL, DOROTHY R. BROTHERTON, AND JULIA R. SWORDS, CO-TRUSTEES, ET AL.,1 Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Nos. 10882-10, 10883-10, 10884-10, 10885-10

United States Tax Court

May 29, 2014

SYLLABUS

R issued notices of transferee liability to Ps to collect D's unpaid Federal income tax pursuant to I.R.C. sec. 6901. R argues that the following two-step analysis applies in determining whether Ps are liable for D's unpaid tax: (1) analyze whether the subject transactions are recast under Federal law, here primarily the Federal substance over form doctrine, and then (2) apply State law to the transactions as recast under Federal law.

Held: I.R.C. sec. 6901 requires that the Court apply State (rather than Federal) law to determine whether a transaction is recast under a substance over form (or similar) doctrine.

Held, further, R has failed to establish that an independent basis exists under applicable State law or State equity principles for holding Ps liable for D's unpaid tax.

Timothy L. Jacobs and William Lee S. Rowe, for petitioners.

Randall L. Eager, Jr., Timothy B. Heavner, Matthew S. Reddington, James R. Rich, Kristina L. Rico, and Johnny C. Young, for respondent.

OPINION

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MARVEL, Judge:

These consolidated cases concern separate notices of liability that respondent issued to the cotrustees of the Julia R. Swords Trust (Swords Trust), the David P. Reynolds Trust (Reynolds Trust), the Margaret R. Mackell Trust (Mackell Trust), and the Dorothy R. Brotherton Trust (Brotherton Trust) (collectively, petitioner trusts).2 Respondent determined in the notices that petitioner trusts are liable as transferees for Davreyn Corp.'s (Davreyn) Federal income tax deficiency of $4,602,986,3 additions to tax under section 6651(a)(1) and (2)4 of $1,160,137 and $1,982, respectively, an accuracy-related penalty under section 6662 of $920,597, fees of $50, and related interest for Davreyn's taxable year ended (TYE) February 15, 2001. The amount of each petitioner trust's transferee liability as calculated by respondent is as follows: Swords Trust--$3,833,988, Reynolds Trust--$2,710,241, Mackell Trust--$3,833,988, and Brotherton Trust--$3,833,988. These calculated liabilities stem primarily from respondent's determination recharacterizing petitioner trusts' February 15, 2001, sales5 of their Davreyn stock as a sale of assets by Davreyn followed by Davreyn's distribution of its assets to petitioner trusts in liquidation.

The sole issue for decision is whether petitioner trusts are liable as transferees under section 6901 for Davreyn's unpaid

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Federal income tax liability for Davreyn's TYE February 15, 2001. We hold that petitioner trusts are not liable as transferees under section 6901.

FINDINGS OF FACT

Some facts have been stipulated and are so found. The stipulations of fact and the facts drawn from stipulated exhibits are incorporated herein by this reference. When the petitions were filed, each petitioner trust had a mailing address in Virginia. Also at that time, Ms. Mackell and Ms. Brotherton resided in Virginia, and Ms. Swords resided in Kentucky.

I. The Reynolds Family and Petitioner Trusts

In 1919 Richard S. Reynolds, Sr., founded the Reynolds Metal Co. (Reynolds Metal). Reynolds Metal produced the popular aluminum foil brand, Reynolds Wrap. Headquartered in Richmond, Virginia, Reynolds Metal was, at one time, the third largest aluminum company in the world.

David Parham Reynolds (Mr. Reynolds), who died on August 29, 2011, was the son of Richard S. Reynolds, Sr., and the sole beneficiary of the Reynolds Trust. The Reynolds Trust was established by an instrument of indenture dated May 14, 1932.

Mr. Reynolds' only children are his daughters: Ms. Swords, Ms. Mackell, and Ms. Brotherton. Ms. Swords and her descendants are the sole beneficiaries of the Swords Trust. Ms. Mackell and her descendants are the sole beneficiaries of the Mackell Trust. Ms. Brotherton and her descendants are the sole beneficiaries of the Brotherton Trust. The Swords Trust, the Mackell Trust, and the Brotherton Trust were established by separate instruments of indenture dated February 22, 1957.

When Mr. Reynolds became ill in the late 1990s, Ms. Swords, Ms. Mackell, and Ms. Brotherton became primarily responsible for managing petitioner trusts. They served as cotrustees for petitioner trusts at all relevant times. Robert H. Griffin, a certified public accountant (C.P.A.) and a partner at the Virginia accounting firm of Mitchell Wiggins

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& Co., LLP (Mitchell Wiggins), has provided accounting and tax services to petitioner trusts for decades.

II. Davreyn

In 1961 Davreyn was established and began business as a Virginia corporation. At all relevant times Davreyn was a personal holding company (PHC). Each petitioner trust received a substantial number of Davreyn shares at the time of Davreyn's formation.

Before June 2000 Davreyn held a substantial number of shares in Reynolds Metal. In June 2000 Reynolds Metal merged with Alcoa, Inc. (Alcoa), another American aluminum company, and Davreyn's existing Reynolds Metal shares were converted into Alcoa shares.

As of February 1, 2001, Davreyn had assets as follows: (1) 409,830 shares of Alcoa stock and (2) an investment in the Goldman Sachs 1999 Exchange Place Fund (Goldman Sachs fund). The value of the Alcoa stock held by Davreyn exceeded $14 million as of February 2001.

As of February 14, 2001, the Swords Trust, the Mackell Trust, and the Brotherton Trust owned all of Davreyn's common stock. Each trust owned 1,656 of the 4,968 issued and outstanding shares of Davreyn's common stock. The Reynolds Trust owned all of the 35,428 issued and outstanding shares of Davreyn's preferred stock.

Also as of February 14, 2001, Davreyn had officers and directors as follows: (1) Ms. Mackell, who served as president, treasurer, and director, (2) Ms. Swords, who served as vice president and director, (3) Ms. Brotherton, who served as vice president and director, and (4) Mr. Griffin, who served as secretary and director. Mr. Griffin also served as an accountant and adviser to Davreyn, and he prepared its Federal income tax returns for its taxable years before the year in issue. Before the transactions at issue, neither Ms. Swords, Ms. Mackell, nor Ms. Brotherton made any change to Davreyn's operation, except for diversifying Davreyn's holdings by investing in the Goldman Sachs fund.

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III. Petitioner Trusts' Sales of Davreyn Stock

A. Initial Meetings and Negotiations

In the late 1990s BDO Seidman, an accounting firm, advised its local offices about an opportunity for PHC shareholders to sell their appreciated PHC stock to a financial buyer in a tax efficient manner. Jon Glazman, a C.P.A. with BDO Seidman, contacted several attorneys, including Tom Word, an attorney at McGuireWoods LLP (McGuireWoods), to inform them of this opportunity. Mr. Word relayed this opportunity to other McGuireWoods attorneys, including Thomas Rohman, a tax partner. Mr. Rohman later contacted Mr. Glazman about a potential sale of PHC stock by clients of Mr. Rohman. Mr. Glazman put Mr. Rohman in touch with Maurice Gottlieb, another C.P.A. at BDO Seidman who specialized in PHC stock sale transactions. Eventually, Mr. Rohman and Mr. Glazman began working together to sell PHC stock to financial buyers. As of the beginning of February 2000 Mr. Gottlieb had structured several transactions similar to the one at issue with the assistance of Mr. Rohman.

Mr. Rohman at some point contacted Mr. Griffin and advised him of the opportunity for shareholders to sell their PHC stock to a financial buyer. Although neither Mr. Griffin nor petitioner trusts were marketing or seeking to market Davreyn, Mr. Griffin recognized that Davreyn was a candidate for this opportunity because Davreyn was a PHC that held highly appreciated stock. On or before February 10, 2000, Mr. Griffin mentioned to Mr. Rohman that Davreyn was such a possible candidate, and Mr. Rohman relayed that information to Mr. Gottlieb.

On February 10, 2000, at Mr. Gottlieb's request, Mr. Rohman sent to Mr. Gottlieb and Mr. Glazman an email providing more detailed information about a potential sale of Davreyn's stock, including information about Davreyn's tax basis in its assets. In the email Mr. Rohman indicated that Davreyn held two assets, the total market value of which was $15,526,639. These assets were: (1) 193,317 shares of Reynolds Metal common stock, with a market value of $14,498,775, and (2) the Goldman Sachs fund shares, with a market value of $1,027,864.

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On March 7, 2000, Mr. Rohman and Mr. Griffin again discussed a potential sale of Davreyn's stock.6 Nine days later, a meeting was held between Ms. Mackell, Ms. Brotherton, Mr. Rohman, Mr. Griffin, and Lizzie Amos, a manager at Mitchell Wiggins. At the meeting Mr. Griffin and Ms. Amos advised Ms. Mackell and Ms. Brotherton that petitioner trusts had five options with respect to Davreyn: (1) continue Davreyn, (2) liquidate Davreyn, (3) sell Davreyn's stock for 90% of the fair market value (FMV) of its assets, (4) sell Davreyn's stock for the sum of 90% of the FMV of the Reynolds Metal stock plus 25% of the FMV of the Goldman Sachs fund shares, or (5) sell Davreyn's stock for 90% of the FMV of the Reynolds Metal stock and distribute the Goldman Sachs fund shares to a limited liability company (LLC). Mr. Griffin advised Ms. Mackell and Ms. Brotherton regarding the potential sale price, as well as the mechanics and tax consequences of a potential sale of Davreyn's stock.

Because of the merger between Reynolds Metal and Alcoa, any plans regarding the sale...

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