Recent Tax Court Decision: Economic Substance and the Step Transaction Doctrine

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Matthew L. Roberts

Matthew L. Roberts

Principal

469.998.8482
mroberts@freemanlaw.com

Mr. Roberts is a Principal of the firm. He devotes a substantial portion of his legal practice to helping his clients successfully navigate and resolve their federal tax disputes, either administratively, or, if necessary, through litigation. As a trusted advisor he has provided legal advice and counsel to hundreds of clients, including individuals and entrepreneurs, non-profits, trusts and estates, partnerships, and corporations.

Having served nearly three years as an attorney-advisor to the Chief Judge of the United States Tax Court in Washington, D.C., Mr. Roberts leverages his unique insight into government processes to offer his clients creative, innovative, and cost-effective solutions to their tax problems. In private practice, he has successfully represented clients in all phases of a federal tax dispute, including IRS audits, appeals, litigation, and collection matters. He also has significant experience representing clients in employment tax audits, voluntary disclosures, FBAR penalties and litigation, trust fund penalties, penalty abatement and waiver requests, and criminal tax matters.

Often times, Mr. Roberts has been engaged to utilize his extensive knowledge of tax controversy matters to assist clients in their transactional matters. For example, he has provided tax advice to businesses on complex tax matters related to domestic and international transactions, formations, acquisitions, dispositions, mergers, spin-offs, liquidations, and partnership divisions.

In addition to federal tax disputes, Mr. Roberts has represented clients in matters relating to white-collar crimes, estate and probate disputes, fiduciary disputes, complex contractual and settlement disputes, business disparagement and defamation claims, and other complex civil litigation matters.

Recent Tax Court Decision: Economic Substance and the Step Transaction Doctrine

A recent Tax Court case illustrates the reach of the economic substance doctrine and the step transaction doctrine.  For the benefit of our readers, we have briefed the case below:

Complex Media, Inc. v. Comm’r, T.C. Memo. 2021-14 | February 10, 2021 | Halpern, J. | Dkt. Nos. 13368-15 and 19898-17

Short Summary: Taxpayer-corporation (Corp.) acquired the assets of a business from a third-party partnership (P’ship).  In exchange for the transferred assets, Corp. issued approximately 5 million shares of common stock.  Immediately thereafter, Corp. redeemed 1.875 million of the common shares held by P’ship in exchange for $2.7 million in cash and Corp’s obligation to make an additional payment of $300,000 a year later.  P’ship paid the cash and assigned its right to the additional payment to one of its partners in redemption of that partner’s interest in P’ship.  Corp. claimed an increased basis of $3 million in intangible assets it acquired from P’ship and amortized that additional basis under I.R.C. § 197(a). The IRS disallowed the deductions under I.R.C. § 197(a).

Key Issues:  Whether Corp. is entitled to the amortization deductions under I.R.C. § 197(a)?

Primary HoldingsYes, in part, because:  (1) Corp’s issuance and immediate redemption of 1,875,000 common shares had no economic substance and should be disregarded under the step transaction doctrine, with the cash and the deferred payment right treated as additional consideration for the assets Corp. acquired from P’ship; (2) the parties agree that I.R.C. § 351 governs the tax consequences of the transactions at issue and accordingly, P’ship recognized gain in the transaction to the extent of the $2.7 million cash it received and the fair market value of its right to the additional $300,000 payment; this increases the basis of the assets transferred to Corp.; and (3) when assets transferred in an I.R.C. § 351 exchange with taxable boot constitute a trade or business, the residual method of allocation prescribed by I.R.C. § 1060 can appropriately be used to allocate the boot among the transferred assets; consequently, P’ship’s gain in amortizable I.R.C. 197 intangibles, and the corresponding increase in asset bases allowed to Corp., is determined by subtracting from the agreed total asset value the estimated values of those assets other than amortizable I.R.C. § 197 intangibles.

Key Points of Law:

Insight: Complex Media is a 103 page reminder of the potential federal income tax complexities inherent in certain taxable or tax-free transactions.  As discussed in the opinion, in many cases, taxpayers are bound to the transactional form they choose, even to their peril.  This can lead to surprising tax results, particularly if not vetted by tax counsel.