Sell Today And Pay Tax in Thirty Years

Sometimes I am amazed to the extent people will go to minimize, defer or avoid taxes altogether.

I get it, though. When that alarm clocks goes off in the morning, there is no government bureaucrat there to prepare your breakfast or drive you to work. Fair share rings trite when yours is the only share visible for miles.

I am looking at an IRS Chief Council Advice.

Think of the Chief Counsel as the attorneys advising the IRS. The Advice would therefore be legal analysis of an IRS position on something.

This one has to do with something called Monetized Installment Sale Transactions.

Lot of syllables there.

Let’s approach this from the ground floor.

What is an installment sale?

This is a tax provision that allows one to sell approved asset types and spread the tax over the years as cash is collected. Say you sell land with the purchase price paid evenly over three calendar years. Land is an approved asset type, and you would pay tax on one-third of your gain in the year of sale, one-third the following year and the final third in the third year.

It doesn’t make the gain go away. It just allows one to de-bunch the taxation on the gain.

Mind you, you have to trust that the buyer can and will pay you for the later years. If you do not trust the buyer’s ability (or intention) to do so, this may not be the technique for you.

What if the buyer pays an attorney the full amount, and that attorney in turn pays you over three years? You have taken the collection risk off the table, as the monies are sitting in an attorney’s escrow account.

You are starting to think like a tax advisor, but the technique will almost certainly not work.

Why?

Well, an easy IRS argument is that the attorney is acting as your agent, and receipt of cash by your agent is the equivalent of you receiving cash. This is the doctrine of “constructive receipt,” and it is one of early (and basic) lessons as one starts his/her tax education.

What if you borrow against the note? You just go down to Fifth Third or Truist Bank, borrow and pledge the note as collateral.

Nice.

Except that Congress thought about this and introduced a “pledging” rule. In short, a pledge of the note is considered constructive receipt on the note itself.

Not to be deterred, interested parties noticed a Chief Council’s Memorandum from 2012 that seemed to give the OK to (at least some of) these transactions. There was a company that need cash and needed it right away. It unloaded farm property in a series of transactions involving special purpose entities, standby letters of credit and other arcane details.

The IRS went through 11 painful pages of analysis, but wouldn’t you know that – at the end – the IRS gave its blessing.

Huh?

The advisors and promoters latched-on and used this Memorandum to structure future installment sale monetization deals.

Here is an example:

(1)  Let’s say I want to sell something.

(2)  Let’s say you want to buy what I am selling.

(3)  There is someone out there (let’s call him Elbert) who is willing to broker our deal – for a fee of course.

(4)  Neither you or I are related to Elbert or give cause to consider him our agent.

(5)  Elbert buys my something and gives me a note. In our example Elbert promises to pay me interest annually and the balance of the note 30 years from now.

(6)  You buy the something from Elbert. Let’s say you pay Elbert in full, either because you have cash in-hand or because you borrow money.

(7)  A bank loans me money. There will be a labyrinth of escrow accounts to maintain kayfabe that I have not borrowed against my note receivable from Elbert.

(8)  At least once a year, the following happens:

a.    I collect interest on my note receivable from Elbert.

b.    I pay interest on my note payable to the bank.

c.    By some miraculous result of modern monetary theory, it is likely that these two amounts will offset.

(9)  I eventually collect on Elbert’s note. This will trigger tax to me, assuming someone remembers what this note is even about 30 years from now.

(10)      Having cash, I repay the bank for the loan it made 30 years earlier.

There is the monetization: reducing to money, preferably without taxation.

How much of the original sales price can I get using this technique?

Maybe 92% or 93% of what you paid Elbert, generally speaking.

Where does the rest of the money go?

Elbert and the bank.

Why would I give up 7 or 8 percent to Elbert and the bank?

To defer my tax for decades.

Do people really do this?

Yep, folks like Kimberly Clark and OfficeMax.

So what was the recent IRS Advice that has us talking about this?

The IRS was revisiting its 2012 Memorandum, the one that advisors have been relying upon. The IRS lowered its horns, noting that folks were reading too much into that Memorandum and that they might want to reconsider their risk exposure.

The IRS pointed out several possible issues, but we will address only one.

The company in that 2012 Memorandum was transacting with farmland.

Guess what asset type is exempt from the “pledging” rule that accelerates income on an installment note?

Farmland.

Seems a critical point, considering that monetization is basically a work-around the pledging prohibition.

Is this a scam or tax shelter?

Not necessarily, but consider the difference between what happened in 2012 and how the promoters are marketing what happened.

Someone was in deep financial straits. They needed cash, they had farmland, and they found a way to get to cash. There was economic reality girding the story.   

Fast forward to today. Someone has a big capital gain. They do not want to pay taxes currently, or perhaps they prefer to delay recognizing the gain until a more tax-favorable political party retakes Congress and the White House. A moving story, true, but not as poignant as the 2012 story.   

For the home gamers, this time we have been discussing CCA 2019103109421213.

Do. Not. Do. This.

Here is the Court:

With respect to petitioner’s Federal income tax for 2013 and 2014, the Internal Revenue Service … determined deficiencies and accuracy-related penalties as follows:

Year  Deficiency Penalty

2013 $338,752    $67,750

2014 7,030,829   1,406,166

I cannot turn down at least skimming a Tax Court case with penalties well over $1.4 million.

Turns out our protagonist is an attorney. He more than dabbled in tax practice:

·      During law school, he took courses in tax law and participated in a tax clinic assisting low-income taxpayers

·      During school he was employed by Instant Tax Services (ITS) in Baltimore. ITS operated on a franchise basis, and he was the area manager for four storefronts. After graduation he served as general counsel for five years.

·      While serving as general counsel, he started acquiring storefronts on his own behalf. By 2013 he owned he owned franchises for 19 locations.

·      These stores were profitable. Aggregate profits exceeded $800 grand over the years 2008 through 2010.

You know, sometimes I wonder what swoon I was in to spend an entire career with a CPA firm. It appears that the money is in setting up and franchising seasonal tax preparation storefronts.

In 2012 ITS attracted the attention of the U.S. Department of Justice – and in a bad way. In 2013 a district court permanently enjoined ITS and its owner from having anything to do with preparing federal tax returns.

COMMENT: Ouch.

Our protagonist was good friends with the owner of ITS. So close, in fact, that Justice refused to allow him to take over the ITS tax preparation business.

COMMENT: Something about helping the ITS owner hide around $5 million.

A third party stepped up to take over the ITS business. This new person formed Great Tax LLC, and many of the ITS franchisees came on board.

Our protagonist was not to be denied, however. He bought the tax preparation software from ITS, put it in an entity called Refunds Plus, LLC (RP), and in turn leased the software to Great Tax LLC.

COMMENT: There is existing commercial tax preparation software, of varying levels of sophistication. We, for example, use software that allows for very complicated returns. It costs a fortune, by the way. There is other software that tones it down a bit, as perhaps the tax practice prepares few or no returns of great complexity. In any event, writing my own software seems a monumental waste of time and money, except for the following tell:

“using this software to process tax returns for GTX customers, most or all of whom expected refunds.”

Most or all?  Riiiigggghht. Perhaps it is just as well that I have stayed with a CPA firm for all these years.

Great Tax LLC paid our protagonist $100.95 for each return it processed and which claimed a refund.

COMMENT: Was a non-refund return free?

Our protagonist worked out an arrangement with Great Tax which allowed him to take money out of Great Tax’s bank account. He also opened a bank account for RP. He moved over $3 million from Great Tax during 2014.

However, he did not deposit the monies from Great Tax into the RP bank account.

So where did the money go?

Who knows.

Since this went to Court, we know that the IRS figured-out what was going on.

Our protagonist agreed that he owed the taxes, but he requested abatement of the penalties for reasonable cause.

He has my attention: what was his reasonable cause?

·      He was a cash-basis taxpayer.

And I like meatball sandwiches. Pray tell what that has to do with anything.

·      There was little to no cash activity in the RP business bank account.

Seriously? Was he aware that failure to deposit funds in its entity-related account is an indicia of fraud?

·      He relied on an attorney.

Reliance on a professional can provide reasonable cause. Tell me more.

·      She had been working as a full-time lawyer for about a year.

Not impressed.

·      She had acquired some of the former ITS franchises.

Had to be a story somewhere.

·      She had represented him when the IRS pressed in a separate action for abuse of the earned income credit.

We just learned where all those refund returns came from.

Let me get this right: his reasonable cause argument is that an attorney prepared his return?

·      No.

Who prepared the return?

·      An accountant.

Why then are we talking about an attorney?

·      She advised our protagonist that he was not required to report the $3 million as gross receipts for 2014.

Our protagonist in turn told the accountant the same thing?

·      Yep. He relied on an attorney.

If this is true, she may be in the running for the worst attorney of the decade.

And why would he – an experienced attorney with some tax background – listen to an attorney with limited experience?

·      The attorney and our protagonist were codefendants in a lawsuit alleging misappropriation of funds.

Yessir.

The Court requested documentary evidence that an attorney would advise that moving approximately $3 million to bank accounts of one’s choosing was not taxable income.

I’m in: I want to see those documents myself.

·      She supplied no evidence of letters, memos or e-mails – dated before those returns were filed – in which she advised petitioner about the reporting of RP’s gross receipts.”

Rain is wet. Nighttime is dark.

How did the Court decide this mess?

We did not find either’s testimony on that point credible. Petitioner’s testimony was self-serving, and [the attorney] did not strike the Court as an objective or candid witness.”

The Court did not believe a word.

Our protagonist owed the tax. He owed the penalties.

Frankly, I am surprised that the IRS did not go after fraud in this case. Perhaps the IRS was prioritizing its limited resources.

I would say our protagonist got off easy.

Folks, this is not tax practice. You know what it is.

Do. Not. Do. This.

Our case this time was Babu v Commissioner, TC Memo 2020-21.