Presidio Advisors, LLC v. United States
| Decision Date | 06 October 2011 |
| Docket Number | No. 05-411T,05-411T |
| Parties | PRESIDIO ADVISORS, LLC, NORVEST LTD., Petitioners, v. THE UNITED STATES, Respondent. |
| Court | U.S. Claims Court |
Partnership tax proceeding; Motion for partial summary judgment; Subchapter S corporation; Qualified Subchapter S subsidiary - 26 U.S.C. § 1361(b)(3)(B); Election to treat subsidiary as a QSub; IRS Notice 97-4; Admission - RCFC 36(b); Admission that S corporation did not own stock of subsidiary on date of election prevented subsidiary from being treated as QSub; Loss deduction based on carry-over basis disallowed; Partial summary judgment granted.
OPINIONTheodore H. Merriam, Denver, CO, for petitioners.
Karen E. Servidea, Tax Division, United States Department of Justice, Washington, D.C., with whom was Acting Assistant Attorney General John A. DiCicco, for respondent.
In this action, petitioners, Presidio Advisors, LLC (Presidio) and Norvest Limited, challenge the IRS' disallowance of $11.4 million in losses claimed by Presidio on its 1998 federal tax return and the assessment of accuracy-related penalties based on the resulting underpayment of tax. Respondent has filed a motion for partial summary judgment on the issue whether Presidio is entitled to a carry-over basis in equipment it acquired from another entity, the sale of which equipment was used to justify the challenged $11.4 million loss. Resolution of this issue requires the court to consider the provisions of Subchapter S of the Internal Revenue Code, as amended in 1996. Based on its review of those provisions, and for the reasons stated, the court GRANTS respondent's motion for partial summary judgment.
A brief recitation of the underlying facts sets the context for this decision.
At various times during 1998, Presidio was a partnership comprised of John Larson; Robert Pfaff; Norwood Holdings, Inc., a subchapter C corporation; and Prevad, Inc. (Prevad), a subchapter S corporation. At the beginning of 1998, Larson and Pfaff each held a fifty percent interest in Prevad through their grantor trusts, the JL Investment Trust and the RP Investment Trust, respectively. Sometime during 1998, Norwood Holdings, Inc. purchased a thirty percent interest and, at approximately the same time, Larson and Pfaff transferred their partnership interests to Prevad.
On May 15, 1998, John Larson, Robert Pfaff, and Helminvest Resources, Inc. (Helminvest), a foreign tax-exempt corporation, formed the Presidio Capital Corporation (PCC). On June 26, 1998, Helminvest contributed to PCC an option to buy certain telecommunications equipment subject to a $1.5 million nonrecourse debt, as well as approximately $100,000 of Norwegian currency. In exchange, PCC assumed the obligation to close a $12 million short sale in U.S. Treasury securities and provided Helminvest with 900 shares of its stock. As a result of this transaction, Helminvest realized a gain of $11.7 million.1 On June 26, 1998, when PCC acquired the option to purchase the telecommunications equipment, the equipment's fair market value was less than $11.8 million.
On October 27, 1998, PCC redeemed all shares from Helminvest, causing John Larson and Robert Pfaff - through their respective grantor trusts - to become the sole shareholders of PCC. On October 30, 1998, PCC exercised its option to purchase the equipment and paid $250,000, subject to the $1.5 million nonrecourse obligation. Presidio set PCC's basis in the equipment as equal to PCC's basis in the option when it was exercised ($10.2 million), plus the cash paid to exercise the option ($250,000), plus the amount of nonrecourse debt assumed by PCC ($1.5 million), or $11,881,813.
On November 6, 1998, Larson and Pfaff, through their trusts, transferred all of PCC's stock to Prevad. On that same day, Prevad transferred its newly-acquired PCC shares to Presidio. Therefore, on November 6, 1998, Prevad did not own one hundred percent of the stock of PCC. On November 8, 1998, PCC transferred the equipment to Prevad, which, on the same day, transferred the equipment to Presidio. In December 1998, Presidio sold the equipment, recording a loss of $11,416,813. Presidio computed its loss by subtracting a claimed basis of $11,881,813 from the sale price of $465,000.
On January 19, 1999, Prevad filed a Form 966 with the IRS. According to this form, Prevad elected to treat PCC as a qualified subchapter S subsidiary (QSub) retroactively, as of October 31, 1998.2 On its 1998 federal tax return (Form 1065), filed on August 19, 1999, Presidio reported gross income of $4,166,311. In computing this figure, Presidio deducted$10,644,471 as a loss from the sale of certain equipment. Presidio calculated this loss by subtracting from the amount realized from the sale ($465,000), a claimed basis of $11,881,813, thereby producing a loss of $11,416,813. Presidio used $10,644,471 of that amount to offset gross income and reported the remaining $772,342 as a nondeductible expense. On its Schedules K-1, Presidio allocated the entire amount of the loss to Larson, Pfaff and Prevad in the amounts of $1.025 million, $1.025 million, and $9.37 million, respectively.
On or about December 29, 2004, the Internal Revenue Service (IRS) issued Presidio a notice of final partnership administrative adjustment (FPAA) for 1998, which, inter alia, increased Presidio's gross income by $10.6 million and reduced its nondeductible expenditures by $772,342. The IRS found that Presidio had failed to establish its basis in the equipment at the time of the alleged sale and that the transaction underlying the claimed loss lacked economic substance and a bona fide business purpose. The FPAA also imposed accuracy-related penalties upon the resulting underpayment of tax
On March 29, 2005, Norvest, the tax matters partner of Presidio, filed this action on behalf of the partnership, challenging the IRS' disallowance of its 1998 loss and the imposition of accuracy-related penalties. On November 17, 2005, the court stayed the proceeding pending a parallel criminal investigation. On March 26, 2009, the stay was lifted and the case was restored to the active docket. Discovery ensued. On September 30, 2010, respondent filed a motion for partial summary judgment. Briefing and argument on that motion is now completed.
We begin with common ground. Summary judgment is appropriate when there is no genuine dispute as to any material fact and the moving party is entitled to judgment as a matter of law. See RCFC 56; Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247-48 (1986). Disputes over facts that are not outcome-determinative will not preclude the entry of summary judgment. Id. at 248. However, summary judgment will not be granted if "the dispute about a material fact is 'genuine,' that is, if the evidence is such that a reasonable [trier of fact] could return a verdict for the nonmoving party." Id.; see also Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986); Becho, Inc. v. United States, 47 Fed. Cl. 595, 599 (2000).
When making a summary judgment determination, the court is not to weigh the evidence, but to "determine whether there is a genuine issue for trial." Anderson, 477 U.S. at 249; see also Agosto v. Immigration & Naturalization Serv., 436 U.S. 748, 756 (1978) (); Am. Ins. Co. v. United States, 62 Fed. Cl. 151, 154 (2004). The court must determine whether the evidence presents a disagreement sufficient to require fact finding, or, conversely, is so one-sided that one party must prevail as a matter of law. Anderson, 477 U.S. at 250-52; see also Ricci v. DeStefano, 129 S. Ct. 2658, 2677 (2009) . Where there is a genuine dispute, all facts must be construed, and all inferences drawn from the evidence must be viewed, in the light most favorable to the party opposing the motion. Matsushita, 475 U.S. at 587-88 (citing UnitedStates v. Diebold, Inc., 369 U.S. 654, 655 (1962)); see also Stovall v. United States, 94 Fed. Cl. 336, 344 (2010); L.P. Consulting Grp., Inc. v. United States, 66 Fed. Cl. 238, 240 (2005).
Subchapter S of the Internal Revenue Code (26 U.S.C. §§ 1361-79) establishes, in considerable detail, the circumstances under which certain "small business corporations" can be treated as flow-through entities for federal tax purposes - "that is, at the individual rather than the enterprise level." Vanisi v. Comm'r of Internal Revenue, 599 F.3d 567, 569 (7th Cir. 2010); see also Information Sys. & Networks Corp. v. United States, 437 F.3d 1173, 1175 (Fed. Cir. 2006); Boris I. Bittker & James S. Eustice, Federal Income Taxation of Corporations and Shareholders ¶ 6.11, pp. 6-78 to 6-79 (7th ed. 2006). If the requirements of this subchapter are satisfied, the corporation may elect to have its income and expenses treated as belonging to its shareholders, with the result that the corporation itself is not separately taxed (similar to the treatment afforded partnerships). See Patton v. United States, 726 F.2d 1574, 1575 (Fed. Cir. 1984). In the parlance of the Code, corporations qualifying for this treatment are called "S corporations."
Prior to 1997, Congress prevented S corporations from being members of affiliated groups. See 26 U.S.C. §1361(b)(2)(A) (1996); see also 11 Mertens Law of Fed. Income Tax'n § 41B:2 (2011). In 1996, however, Congress amended the Code to allow such S corporations to have wholly-owned subsidiaries, known as "qualified subchapter S subsidiaries." See Small Business Job Protection Act of 1996, Pub. L. No. 104-188, sec. 1308, 110 Stat. 1785.3 Such "QSubs" are also disregarded for tax purposes - their income passes all the way through to the S Corporation's shareholders...
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