Block Developers, LLC v. Comm'r
| Decision Date | 18 July 2017 |
| Docket Number | Docket No. 23600-12.,T.C. Memo. 2017-142,Docket No. 23599-12,Docket No. 3198-10,Docket No. 23598-12 |
| Parties | BLOCK DEVELOPERS, LLC, WILLIAM J. MAXAM, APC, TAX MATTERS PARTNER, ET AL., Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | United States Tax Court |
Bruce Michael O'Brien and Laura L. Buckley, for petitioners.
Anna A. Long, Monica D. Polo, and Jeffrey L. Heinkel, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Southern Californians want to live on hills, but southern California hills want to slide toward the sea. The primary taxpayer in these cases, Jan Jansson, is an expert in making these opposing forces work together. He moved from Sweden to Los Angeles in the '80s and invented a type of interlocking concrete block that better enables builders to construct roads and homes on hillsides. The blocks themselves then disappear from view--he designed them to allow vegetation to grow through and around them--while they perform their function of containing the lateral thrust of a hill on its base.
As he neared retirement Jansson opposed a more relentless force--the IRS. He thought he had found a way to cut his income tax and preserve his wealth from estate tax by creating a partnership that would be owned by a series of Roth IRAs. He argues that it's a solid wall between the Commissioner and his wealth; the Commissioner argues that it's only a paper barrier.
Jansson and his wife of more than 50 years, Margareta, were born in Sweden. Jansson went to carpentry school there and began his career in construction. Though carpentry school provided him a fine education, Jansson earned an engineering degree in 1964 from Stockholm Higher Technical College. He then moved out of wood and earned a postgraduate degree in concrete. In 1969 he began to build a career by founding a construction company. Jansson's wife and their two then-young sons (Fred and Niklas) immigrated to the United States in 1983, and Jansson stayed behind to sell his company. When he had, he rejoined his family in California.
His American story begins with an earlier kind of concrete block--the Loffel Block. Loffel Blocks2 are a patented type of concrete block used to build retaining walls. Soon after arriving in the United States, Jansson partnered with two other men--one of whom also had some experience in the concrete business--and together they signed an agreement to license the right to make and sell these blocks. Jansson and his partners planned to sell retaining walls and use separate teams to produce and install the blocks. But the plan failed before the licensing term even ended: Errors in the manual provided by the Loffel licensor led to a lawsuit. Jansson settled the suit on favorable terms, under which he was able to make and sell blocks under the Loffel license free from any obligation to pay royalties.
In June 1987 Jansson ventured out on his own and formed a corporation that he eventually named Soil Retention Systems, Inc.3 Jansson was, and continues to be, SR Systems' sole shareholder. SR Systems at first just distributed Loffel Blocks throughout southern California but Jansson formed an LLC to build a new plant in Perris, California, to make the blocks. SR Systems then made and sold these blocks for many years.
Jansson had bigger ambitions, though--he thought he could build a better block. He wanted something more durable, more versatile, and more plantable. His first innovation was a block that one could plant in the ground. He won a patent on that design in the mid-'90s and for a time continued to work on his designs and market both his blocks and the Loffel Blocks. But he kept tinkering, and finally developed the Verdura Block System at the turn of the century.
The Verdura Block System, like Loffel Blocks, is used to build retaining walls. It's meant to counteract the lateral force created by gravity and the mass of the soil. For lower walls, the simple weight of a single wall of blocks keeps things where they are supposed to be. What makes the Verdura Block System novel, though, is that the blocks interlock to form a grid. The system works in a single tier to a height of 49 feet, with multiple tiers backfilled with up to 30 cubic yards of dirt behind them. The blocks are also capable of supporting vegetation. The effect is pleasing to the eye and makes buildable lots on hills that otherwise would not support them. The system was a success and has been used in the construction of casinos, resorts, golf courses, parks, and even the San Diego Zoo.
Jansson heavily marketed the system. He went to local trade shows, distributed brochures, and placed ads in building magazines. He visited general contractors, engineers, and architects to show them his product. Home Depot eventually approached Jansson and advertised the Verdura Block System on televisions in the store.
This lifetime of work has led to great success in his field, and Jansson justly considers himself an expert in concrete and concrete products. He currently sells his Verdura Block System at 30-40 outlets--it remains his biggest seller4--and he himself now belongs to no fewer than ten trade associations.
But success had led Jansson to worry. America is more lawsuit-happy than Sweden, and as Jansson's operations grew and diversified over the years he started to fear potential liability. He split his activities into different companies:
• Toy Rentals: An S corporation that Jansson formed in 1993. It owns the equipment used to install the blocks. Though it has no employees, it rents its equipment to Jansson's other S corporations as needed.
• SR Products: An S corporation that Jansson formed in 1998. SR Products has about thirty employees and immediately after its incorporation took over the manufacturing and distribution of the blocks from SR Systems.
• SR Designs: An S corporation that Jansson formed in 2004. SR Designs lays out the grading plans for particular jobs with the help of a civil engineer and has only a few employees.
Jansson's entire family derives financial support through their roles in the SR businesses. Jansson's son Niklas is--according to Jansson--the vice president of each business, but as a formal matter Niklas is the vice president of SR Systems only. Julia Jansson (Niklas's wife) is something like an office manager for each business--but also something more, as she tends to the wide range of chores that Jansson gives her.
Such informality is rampant within the companies. Though each business technically runs a separate portion of Jansson's overall enterprise, there is a great deal of everyday overlap. SR Systems employs about thirty people as foremen, laborers, and machine operators, but all share the same office space and phone number with SR Products and SR Designs. It's not just personnel--neither management nor resources are strictly split between them. And much of the documentation Jansson produced about these businesses bears the name only of "Soil Retention".
Jansson wanted his businesses to survive his retirement; and he credibly testified that although he was unfamiliar with estate planning, he did have a general goal in mind: He wanted to be able to get money out of the businesses, and had previously toyed with the idea of selling his patents but a deal never materialized. Looking for some guidance, he started going to seminars about retirement and pension planning. And at one of these he met Bill Maxam.
Maxam became the Janssons' estate planner. He himself has an entrepreneurial edge; while he practiced law for more than 40 years, he found the time to build and manage four apartment buildings and three houses and even owns a chain of coin laundries. Somewhere between late 1997 and throughout 2001 Maxam met with Mr. and Mrs. Jansson four or five times, and came up with a complicated retirement plan that featured a role for himself as investor as well as adviser. It called for him to buy two of Jansson's most successful patents, each member of the Jansson family to open a Roth IRA, and Jansson to form a fifth business entity--a partnership with Maxam himself.
In January 2001 Jansson and Maxam signed a purchase option in which Jansson irrevocably granted Maxam the right to buy his Verdura Block patents for an amount "to be negotiated and paid" within the year. Jansson's stated reason for selling the patents was to replenish his cash after he'd spent a great deal on the factory in Perris. This prospective sale was coupled with another option, this one between SR Products and Maxam, under which Maxam agreed to pay SR Products 10% of its gross sales of blocks produced under the patents if the option were exercised. (It's not clear from the record how Maxam and SR Products decided on this rate.) That license option was for two years.
The next step was to create Roth IRAs, and this was done in April when Jansson, his wife, Fred, and Niklas opened self-directed Roth IRAs. Each Jansson made a $2,000 initial deposit. Each Jansson was the sole beneficiary of his or her Roth IRA, and each retained the authority to direct its investments.
Maxam then formed Block Developers, LLC, under Nevada law.5 The parties stipulated that an amendment to Block Developers' articles of organization made Maxam its sole member and William J. Maxam, APC, its tax matters partner (and later a member). It was several months before Maxam opened a bank account for Block Developers. This was Block Developers' only account, and Maxam has held sole signature authority on it since it opened.
Next on the agenda was putting the Roth IRAs to work. Maxam drafted subscription agreements for each Jansson family Roth IRA and one for Maxam APC. Each Jansson signed his agreement on behalf of his Roth IRA and through this obtained an interest in Block Developers:
Entity Ownership (percentage) Mr. Jansson Roth IRA 23.75
... Mrs.
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