United Dairy Farmers v. U.S.A., 00-3800
| Decision Date | 02 August 2001 |
| Docket Number | No. 00-3800,00-3800 |
| Citation | 267 F.3d 510 |
| Parties | (6th Cir. 2001) United Dairy Farmers, Inc., et al., Plaintiffs-Appellants, v. United States of America, Defendant-Appellee. Argued: |
| Court | U.S. Court of Appeals — Sixth Circuit |
Appeal from the United States District Court for the Southern District of Ohio at Cincinnati. No. 97-01043, Sandra S. Beckwith, District Judge. [Copyrighted Material Omitted] Stephen M. Nechemias, J. Donald Mottley, TAFT, STETTINIUS & HOLLISTER, Cincinnati, Ohio, for Appellants.
Richard Farber, Thomas J. Sawyer, UNITED STATES DEPARTMENT OF JUSTICE, TAX DIVISION, Washington, D.C., for Appellee.
Before: CLAY and GILMAN, Circuit Judges; WISEMAN, District Judge.*
Plaintiffs, United Dairy Farmers, Inc. et al. ("UDF"), appeal from the district's court order dismissing UDF's claims brought pursuant to 26 U.S.C. §6226(e), for readjustment of the Internal Revenue Service ("IRS") determination disallowing several corporate income tax deductions taken by UDF in 1993 under 26 U.S.C. §§ 162 and 165(a) of the Internal Revenue Code ("the Code"). We AFFIRM.
On July 25, 1994, UDF filed a federal income tax return for its 1993 taxable year, claiming several deductions for ordinary business expenses pursuant to § 162, and abandonment losses pursuant to § 165, of the Code. On June 27, 1997, the IRS issued a Notice of Final S Corporation Administrative Adjustment disallowing some of these deductions from UDF's ordinary income. On November 21, 1997, UDF paid $7,744 to the IRS, the amount by which the adjustments increased UDF's tax liability, and filed a petition for readjustment pursuant to 26 U.S.C. § 6226(e) to refund the payment. On May 23, 2000, following a two-day bench trial, the district court entered judgment in favor of the government. See United Dairy Farmers v. United States, 107 F.Supp.2d 937, 949 (S.D. Ohio 2000). UDF now appeals.
On May 23, 2001, this Court granted the government's motion to take judicial notice of certain discovery responses made by UDF during the district court proceedings, namely, that UDF admitted that no part of its $259,980 of environmental cleanup costs was allowable as a bad debt deduction in 1993.
UDF is an Ohio corporation with its principal place of business in Cincinnati. UDF manufactures and distributes milk and ice cream products to its own convenience stores, and also sells its products to over 1,000 wholesale accounts in a six-state region. At issue in this case are three categories of expenses incurred by UDF: soil remediation, corporate reorganization, and engineering studies.
In 1989, UDF purchased two stores, numbered 649 and 140, located respectively on properties in Columbus and Cincinnati, Ohio, that contained underground gasoline storage tanks left by prior occupants. On both properties, the tanks had leaked, causing soil contamination. UDF purchased the store 649 property for $315,000, and the store 140 property for $450,000.1 The properties for store 649 and store 140 were each worth less in a contaminated state than the prices paid for them by UDF. Although UDF may not have been aware of the underground tanks prior to the closing date for two purchases, UDF was aware, by that time, of soil contamination on both properties.2
In 1990, UDF spent $136,864 on soil remediation for the store 649 property. In 1991, UDF spent $123,698 on soil remediation for the store 140 property. In 1993, UDF took a $259,980 deduction under § 162 for the cleanup costs. On audit, the IRS determined that these costs could not be deducted, which the district court affirmed.
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.
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 S corporation, called Uncle Bud's Fried Dough, Inc.
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.
In a sworn statement describing the merger, a UDF official provided that (J.A. at 330.)
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.
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.
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.
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.
UDF's main office is in Norwood, Ohio. In the early 1990s, UDF began looking for a site on which to build a distribution facility that would house its own cold storage warehouses. Between 1991 and 1993, UDF paid Hixson, Inc., an engineering and design firm, to assist in locating an appropriate site. Hixson examined several potential sites. UDF intended to build only one distribution facility. Of the $55,000 spent by UDF to examine competing sites, only $16,500 related to the Erlanger, Kentucky site that was ultimately chosen.
On its 1993 tax return, UDF claimed that it could deduct those studies that related to all of the properties other than the Erlanger site, which had been abandoned upon deciding to go ahead with the Erlanger site. The government contended that UDF had engaged in one single project, which was to study available sites and build one distribution facility. Because the Hixson fees were incurred pursuant to one single plan, the government contended that all of the fees must be capitalized. The district court agreed with the government, finding that the fees were part of an integrated plan to build one distribution center and must be capitalized.
In the 1980's, the ice cream room at UDF's Norwood facility was operating at capacity. From late 1986 to late 1987, Hixson created plans to develop vacant space adjacent to the ice cream room so that production of a microwavable milk shake product, which had become popular, could be expanded. For a variety of reasons, UDF decided not to expand the ice cream room. Instead, in 1988, UDF converted the vacant space into a computer room, and never implemented the development plans. UDF paid Hixson $37,327 for its work in 1986 and 1987 on developing the vacant space.
In 1986, UDF retained Sieberling to design a "clean-in-place" ("CIP") system that would help separate the "raw" and "pasteurized" compartments of a milk manufacturing facility. The CIP system is an automated process for cleaning the lines in UDF's plant. At the same time, Sieberling also looked at automating a portion of the ice cream manufacturing process. UDF paid Sieberling $31,906 for its work between 1986 and 1988. After 1993, UDF commissioned a new study from a different consultant to automate the portion of the ice cream manufacturing process that Sieberling had been researching.
In 1990, UDF commissioned a study from Bonar Engineering to increase the freezing capacity at the Norwood plant, for which it paid $4,300. The project was not implemented.
UDF also commissioned, for $22,000, an advanced handling systems study in 1992, relating to "movement" of UDF products from the factory to retail stores. UDF could still implement the study in Norwood, but has not done so because its current method of moving products is less expensive.
UDF deducted each of the Norwood studies in 1993 on the theory that it had abandoned...
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