Watkins v. Comm'r
| Decision Date | 25 September 2014 |
| Docket Number | Docket No. 26041-11,Docket No. 26096-11,T.C. Memo. 2014-197 |
| Parties | GREGORY S. WATKINS AND LINDA WATKINS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent DAREN J. BARONE AND COLLEEN R. BARONE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | United States Tax Court |
Steven R. Toscher, Lacey E. Strachan, and Richard Carpenter, for petitioners.1
Monica D. Polo and Mistala M. Cullen, for respondent.
WHERRY, Judge: These cases, which we have consolidated for purposes of this opinion only, are before the Court on petitioners' motions for summary judgment, motions for partial summary judgment, motions to dismiss for lack of jurisdiction, and motions to reconsider orders granting respondent's motions for leave to amend the answers.2
These cases and the related litigation have a rather tortuous background. At the heart of these cases is the ownership structure of an asbestos removal business set up by petitioners Gregory Watkins and Daren Barone. Much of the factual background underpinning that ownership structure and the reasons behind it can be found in our prior opinion, WB Acquisition, Inc. v. Commissioner, T.C. Memo. 2011-36 (WBA Cases), and much of this background information comes from those factual findings.
Messrs. Watkins and Barone owned an asbestos removal company called Watkins Contracting, Inc. (WCI), which they purchased from Mr. Watkins' father in the mid-1990s. They sold WCI shortly thereafter to REXX Environmental Corp. (REXX). Messrs. Watkins and Barone stayed on with WCI as employees.
REXX began to experience financial difficulties which in turn affected WCI's ability to bond projects. Because the executives of REXX were unwilling to sign personal guaranties for bonds for WCI, REXX asked Messrs. Watkins and Barone to personally guarantee bonds in exchange for a percentage of profits from the projects. Eventually, REXX asked Messrs. Watkins and Barone if they wantedto repurchase WCI. They were reluctant to do so without a structure in place that would limit their personal exposure. Ultimately they agreed upon a structure and repurchased WCI for approximately one-third of what they sold it for.
Under the new ownership structure, WCI would be owned by a newly formed C corporation, WB Acquisition, Inc. (WB Acquisition). In turn WB Partners, which was a partnership for Federal income tax purposes, owned WB Acquisition. Two S corporations, DJB Holding Corp. (DJB Holding) and GSW Holding Corp. (GSW Holding), were 50-50 partners in WB Partners. The sole shareholder of DJB Holding was an employee stock ownership plan, DJB Holding Corp. ESOP (DJB ESOP), in which Mr. Barone was the lone participant. Similarly, Mr. Watkins was the sole participant of GSW Holding Corp. ESOP (GSW ESOP), which was the sole shareholder of GSW Holding.
Respondent issued notices of final partnership administrative adjustments (FPAAs) to WB Partners for the 2003, 2004, and 2005 tax years, notices of deficiency to WB Acquisition for the 2002, 2003, 2004, and 2005 tax years, and notices of deficiency to petitioners for their 2002 through 2005 tax years. Timely petitions to this Court followed, and these cases, seven in all, were consolidated. Ultimately, the FPAAs for WB Partners and the notices of deficiency for WBAcquisition were the subject of the opinion in the WBA Cases, in which we entered a decision on November 28, 2011.
Of importance here are respondent's concessions in the WBA Cases, which led to the severance of petitioners' individual income tax cases.3 Respondent conceded that WB Partners, DJB Holding, GSW Holding, and the two ESOPs are not shams for Federal income tax purposes and that DJB Holding and GSW Holding were true partners of WB Partners. What necessarily follows from these concessions is that Messrs. Watkins and Barone are neither direct nor indirect partners in WB Partners.4
Once petitioners' cases were severed, respondent's concessions had several consequences. First, by order dated April 22, 2010, we dismissed the 2004 and2005 tax years for lack of jurisdiction. We found the proposed adjustments stemmed from partnership items, which were properly the subject of the partnership proceeding and that the notices of deficiency as to the 2004 and 2005 tax years were invalid. With respect to the 2003 tax years, however, we found that petitioners made a valid section 6223(e)(3)(B) election, which allowed us to treat partnership items as nonpartnership items for that year. Respondent conceded that Messrs. Watkins and Barone were not direct partners of WB Partners during 2003. Because they held their interests in WB Partners through ESOPs, which are not "pass-thru partners" within the meaning of section 6231(a)(9), we found that they were not indirect partners during 2003 either. Accordingly, because Messrs. Watkins and Barone were neither direct nor indirect partners of WB Partners, the section 6223(e)(3)(B) election became meaningless. On March 6, 2012, we granted summary judgment in favor of petitioners and decided that there were no deficiencies or underpayments of income tax for petitioners' 2003 tax year.
Respondent moved to vacate those decisions on the grounds that petitioners realized an accession to wealth through their dominion and control over the funds in the holding corporations. We denied these motions, but we noted that respondent's motion to vacate Respondent did not appeal our decisions as to the 2003 tax year, and they became final.
In the current cases, respondent seeks to assert the dominion and control theory that he advanced too late for petitioners' 2003 tax years. In notices of deficiency dated August 11, 2011, respondent determined deficiencies and penalties as follows:
Couple
Year
Deficiency
Penalty
The Barones
2004
$1,388,735
$277,746.60
2005
693,202
138,189.00
The Watkinses
2004
1,395,722
279,143.00
2005
684,950
The deficiencies stem from other income of $3,946,342 and $1,952,026 that respondent alleges both couples received for the 2004 and 2005 tax years, respectively. These items of other income, as petitioners emphasize, bear a remarkable similarity to distributions made by WB Partners to DJB Holding and GSW Holding in those tax years, $3,946,342 to each partner for 2004 and$1,952,026 to each partner for 2005. By way of explanation, the notices of deficiency include the following cursory statements:
It has been determined that you failed to report gross income of $3,946,342.00 and $1,952,026.00 for the tax years ending December 31, 2004, and December 31, 2005, respectively. Gross income includes all accessions to wealth from actual receipt and/or constructive receipt of income. Income is constructively received when it is credited to your account, unconditionally set apart for you, or otherwise made available so that you could draw upon it at any time.
Petitioners timely petitioned this Court for redetermination on November 14, 2011. Both couples lived in San Diego County, California, at that time. After petitioners filed their motions for summary judgment, motions for partial summary judgment, and motions to dismiss for lack of jurisdiction, respondent filed his responses objecting to the motions, and both parties filed memoranda of law in support of their positions. While these motions were pending we granted respondent's motions, on December 3, 2012, for leave to amend the answers.
In 2005 petitioners decided to unwind the ESOP ownership structure. On November 30, 2005, the ESOPs entered into agreements with the respective S corporations in which each of the S corporations agreed to purchase and redeem its 990 shares of stock held by the respective ESOP for roughly $500,000. Theparties executed these agreements on the same day. Also on the same day, Messrs. Watkins and Barone were granted and immediately exercised their rights, under stock option agreements, to purchase 100 shares of stock from their respective S corporations for $1 per share. In his amended answers, respondent seeks to recharacterize these transactions as taxable distributions from a qualified retirement plan, resulting in taxable income equal to the amount of retained earnings of GSW Holding and DJB Holding.5
A hearing was held in San Diego, California, on December 10, 2012.
On December 3, 2012, we granted respondent's motions for leave to amend the answers over petitioners' objections. Respondent's...
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