Transaction Treated as Sale of Stock, Built-In Gain Tax Triggered

A taxpayer found that the transaction he entered into to attempt to delay gain recognition to get outside the built-in gain period of his S corporation failed to succeed in the case of Anschutz Company v. Commissioner, 135 TC No. 9.

Having acquired the Staples Center in Los Angeles and two professional sports team, Philip Anschutz needed some cash.  His wholly owned S corporation’s, which has elected its status only a year before, held a number of highly appreciated securities in a subsidiary it owned that had elected QSUB status.  A sale of the shares would trigger the built-in gain tax of §1374 along with individual income taxes at the shareholder level, so Mr. Anschutz looked to avoid that result.

To accomplish that goal, he entered into a pair of transactions, one where the corporation entered into a prepaid variable forward contract (PVFC) involving various appreciated shares he held, and another that required him to lend those same shares to the investment bank with which he entered into the agreements with under a share-lending agreement (SLA).  The transactions would ultimately finish up after the 10 year built-in gain period at which time, in the taxpayer’s view, any gain or loss would be recognized.

The agreements limited the QSUB’s ability to participate in appreciation of the underlying shares to no more that 50% of the value when the contract was entered into—all additional appreciation accrue to the benefit of the investment bank.  Similarly, because the PVFC could be settled by delivering the initial number of shares, the QSUB had locked in the lowest price it would receive for the shares, that being the initial 75% value received.

The taxpayer contended that the two transactions had to be evaluated separately citing the Tax Court’s decision in Samueli v. Commissioner, 132 TC 37, while the IRS contended that rather they were an integrated whole.  The Tax Court sided with the IRS, finding that the taxpayer had misinterpreted the holding in Samueli which involved an arrangement the taxpayers argued they could have (but did not) enter into.  The Court found that, viewed as a whole, the QSUB transferred all risk of loss and most of the opportunity for gain when it executed this pair of transactions.

The Court also refused to consider that the QSUB had the right to recall the lent shares and, in fact, did so twice after the examination commenced.  The Court pointed out the recalls were not done for any valid economic reason, but rather solely to try and influence the result in the case.  The taxpayers, being insulated from loss by the overall arrangement, could not obtain the protection of §1058 for the lending transactions, as the loss protection violated the requirements of §1058(b)(3).

However the Court did not agree with the IRS that the QSUB should be taxed on the full fair value of the shares transferred.  The IRS argued that, effectively, the QSUB had received 75% in cash and the remainder in equity options. The Tax Court rejected that view, holding that the amount to be received cannot be determined until the contract is settled, so only payments received by the QSUB would be taxable.

Advertisement