Feldman v. Comm'r
| Decision Date | 24 February 2015 |
| Docket Number | 12–3149,12–3150,12–3146,12–3148,12–3807.,12–3147,12–3145,Nos. 12–3144,s. 12–3144 |
| Citation | 779 F.3d 448 |
| Parties | Ray FELDMAN, et al., Petitioners–Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee. |
| Court | U.S. Court of Appeals — Seventh Circuit |
Robert E. Dallman, Attorney, Daniel B. Geraghty, Attorney, Thomas R. Vance, Attorney, Whyte Hirschboeck Dudek S.C., Milwaukee, WI, for Petitioners–Appellants.
Francesca Ugolini, Attorney, Kenneth L. Greene, Attorney, Department of Justice, Washington, DC, for Respondent–Appellee.
Before MANION, KANNE, and SYKES, Circuit Judges.
This appeal raises a question of transferee liability under 26 U.S.C. § 6901 for a dissolved corporation's unpaid federal taxes. The “transferees” are the former shareholders of a closely held Wisconsin corporation that for many decades owned and operated a dude ranch in the northwestern part of the state. When the ranch was sold, the shareholders planned to liquidate, but the asset sale had produced a sizable gain and the corporation faced significant federal and state tax liability. A tax-shelter firm swooped in with a proposal for an intricate tax-avoidance transaction as a more profitable alternative to a standard liquidation. This should have called to mind the warning that “if something seems too good to be true, then it probably is.” But alas, it did not. The shareholders took the deal, effectively liquidating the corporation without absorbing the financial consequences of the tax liability. The taxes were never paid.
The IRS sought to hold the former shareholders responsible for the tax debt as transferees of the defunct corporation under § 6901 and Wisconsin law of fraudulent transfer and corporate dissolution. The tax court sided with the IRS and found the shareholders liable for the unpaid taxes and penalties. We affirm.
William Feldman founded Woodside Ranch in the 1920s. Located in the small town of Mauston in northwest Wisconsin, the ranch was incorporated in 1952 as Woodside Ranch Resort, Inc. (“Woodside”) and was treated as a Subchapter C corporation for federal tax purposes. Over time the ranch came to offer a wide array of outdoor activities, including horseback riding, boating, and snowmobiling. Until its sale in 2002, Woodside was owned and operated by the descendants of its founder.
By the late 1990s, the ranch was facing a number of challenges to its ongoing viability. Nearby casinos and water parks competed with the ranch for business, the next generation of Feldmans had no interest in continuing to run the ranch, and the shareholders and directors were approaching or had already reached retirement age. At this point Woodside had ten shareholders, all descendants of its founder.1 Lucille Nichols, daughter of founder William Feldman, was the president; grandsons Richard Feldmann and Ray Feldman were vice-president and secretary, respectively;2 and great-granddaughter Carrie Donahue was the treasurer. The shareholders decided it was time to sell.
Selling the ranch raised a number of concerns. In particular, the shareholders anticipated that the corporation would incur significant tax liability. Woodside's assets had been purchased long ago, so a sale would give rise to a large taxable capital gain. The shareholders also worried about future personal-injury claims against the resort. The outdoor activities at the ranch inevitably produced some accidents and injuries every year. Most were minor, few resulted in formal claims, and most claims were settled in kind with free return visits and payment of medical expenses. Sometimes personal-injury claimants sought monetary damages, but apparently not often enough to justify purchasing expensive liability insurance; premium estimates were in the $200,000 to $400,000 range, so Woodside opted not to carry liability coverage.
In the fall of 2001, the shareholders opened negotiations to sell the ranch to Damon Zumwalt. They proposed a stock sale, but Zumwalt rejected it out of hand and insisted on an asset sale. The shareholders accepted Zumwalt's terms, and the transaction closed on May 17, 2002. Zumwalt formed Woodside Ranch LLC and purchased Woodside's assets for the sum of $2.6 million and certain noncompete and consulting agreements. The parties expected that Zumwalt would continue to operate the ranch.
After the asset sale, Woodside—the Feldman family's corporation, not the ranch—ceased carrying on any active business. It was, in the words of shareholder and secretary Ray Feldman, an “empty shell” consisting of cash on hand along with a few notes and receivables.
The asset sale had netted about $2.3 million, resulting in a taxable capital gain of $1.8 million (on a basis of approximately $510,000). This triggered combined federal and state tax liabilities of about $750,000. While the asset sale to Zumwalt was still pending, Fred Farris, Woodside's accountant and financial advisor, introduced the shareholders to representatives of MidCoast Credit Corp. and Midcoast Acquisition Corp. (collectively “Midcoast”). Owned by Michael Bernstein and Honora Shapiro, Midcoast specialized in structured transactions designed to avoid or minimize tax liabilities. As relevant here, Midcoast offered to purchase the stock of C corporations like Woodside that had recently experienced a taxable asset sale, promising to pay more for the shares than they were worth in a liquidation. Then, using bad debts and losses purchased from credit-card companies, Midcoast would offset (i.e., eliminate) the unpaid tax liabilities of the acquired corporation by way of a net-operating-loss carryback.
Billed as a “no-cost liquidation,” Midcoast proposed this strategy to Woodside's shareholders as an attractive tax-avoidance alternative to liquidating the corporation. As part of the pitch, Midcoast sent promotional materials outlining the structure of the transaction and explaining that selling their stock to Midcoast would yield a higher return for the shareholders than a standard liquidation by reducing the tax consequences of Woodside's asset sale.
Woodside's finance committee (Richard Feldmann, Ray Feldman, and Carrie Donahue) initially recommended liquidation, but Woodside's board of directors opted to pursue Midcoast's tax-avoidance strategy and entered into negotiations for a stock sale to Midcoast. On June 17, 2002, the finance committee held a conference call with Midcoast representatives to discuss the specifics of the transaction. On June 18 Midcoast sent a letter of intent offering to buy 100% of Woodside's stock for a price equal to the cash in the company as of the closing date reduced by 70% of the tax liability. Stated differently, the purchase price represented Woodside's liquidation value (about $1.4 million) plus a “premium” of about $225,000. Ray Feldman transmitted the proposal to the shareholders by letter the next day, noting that:
MidCoast promises ... to pay Woodside's taxes because the corporation would not be liquidated but instead be kept alive as a going concern as a part of the MidCoast organization. This deal is profitable for MidCoast because MidCoast purchases large amounts of defaulted and delinquent credit card accounts from the major credit card companies ... and carries forward such losses to offset against the purchase of “profitable” corporation[s] such as Woodside.
Although this letter mentions a “promise” by Midcoast to pay Woodside's taxes, all shareholders understood that Midcoast intended to claim a loss to offset the capital gain from the sale of the ranch.
The shareholders met to discuss Midcoast's proposal and ultimately approved it. As the deal moved forward, the shareholders conducted some basic research on Midcoast. For example, they obtained a Dunn & Bradstreet report on the firm and called a few of Midcoast's references.
The transaction closed on July 18, 2002. The parties signed a share purchase agreement with a purchase price equal to Woodside's cash on hand less $492,139.20 (about 70% of Woodside's tax liability). The agreement stated that Woodside had no liabilities other than federal and state taxes. Midcoast was prohibited from liquidating or dissolving Woodside within four years of the stock sale. (Farris suggested adding this term based on concerns about the shareholders' liability if Midcoast did not pay Woodside's taxes.) The agreement also capped the shareholders' liability for any future personal injury claims at an amount equal to the “premium.” This was a point of contention during negotiations, but Midcoast ultimately agreed to the liability cap.
The closing involved a number of steps in quick succession on July 18. First, Woodside redeemed 20% of its stock directly from the shareholders. The proceeds of this transaction were transferred to Woodsedge LLC, an entity specially created by the shareholders to receive the proceeds of the stock sale. The precise purpose of the redemption is not entirely clear from the record, but afterward Woodside's only asset was cash in the amount of about $1.83 million; the corporation had no liabilities other than federal and state taxes—again, approximately $750,000—and unknown future personal-injury claims.
The parties then executed the share purchase agreement and two escrow agreements to facilitate the transaction. The shareholders and Midcoast were parties to the first escrow agreement; Midcoast and Honora Shapiro—50% owner of Midcoast—were parties to the second. The law firm of Foley & Lardner was the escrow agent under both agreements, and funds were wired into and out of its trust account as follows. First, at 12:09 p.m. on July 18, Woodside's cash reserves of $1.83 million were transferred into the trust account. Then, at 1:34 p.m. Shapiro transferred $1.4 million into the trust account, purportedly as a loan to Midcoast to fund the transaction, although there is no promissory note or other writing evidencing a loan, and (as we will see) the money was immediately...
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