The drought is over, at least with regard to valuation cases in the U.S. Tax Court. This was the message Prof. John A. Bogdanski (Lewis & Clark Law School) delivered during a recent BVR webinar, "Business Valuation in the Federal Tax System in 2014." The court had been bogged down with other matters, but BV is now back on its calendar.

Bogdanski, an authority on the Tax Court, also detected a theme linking several of the most noteworthy 2014 valuation cases: ownership of goodwill or similar intangibles.

Goodwill doctrine: This is not a new issue, Bogdanski says, but the court has not spent much time on it since the 1998 Martin Ice Cream Co. case involving the shareholder of a company introducing Häagen-Dazs to New Jersey. When the corporation spun off its supermarket distribution rights to a subsidiary wholly owned by the company’s sole shareholder, he transferred them to Häagen-Dazs along with the subsidiary's business records, customer records, and associated goodwill. The IRS argued that the ice cream company was liable for the gain from the sale of the subsidiary, but the court said the shareholder personally owned the customer relationships and distribution rights. The company could not distribute assets it did not own.

Possible push back: Fast-forward to 2014 and the Adell estate tax case. In valuing the decedent’s 100% interest in a for-profit satellite company providing uplinking services to a nonprofit religious network the decedent’s son had built, the court (J. Paris) found the IRS’s expert significantly undervalued the pivotal role the son played in operating both companies as well as the critical relationships he built with contributors to the religious network. The son, the court said, owned the asset of goodwill and, since he never transferred it by way of a noncompete, he could compete directly with the company.

Not quite so, Bogdanski says. The court ignores black-letter corporate law under which the son, as a director of the subject company, had a fiduciary duty of loyalty to the company, regardless of whether he had a contractual obligation to the company. A hypothetical buyer would have challenged the son in state court from competing directly with the acquired company. The IRS expert’s valuation actually may have reflected the son’s role more accurately, Bogdanski concludes.

Cavallaro was a gift tax case with a similar story line but a very different outcome. Here, too, a father built a successful business, along with his sons, and achieved great financial success. Much of it was due to a machine the owners conceived together but built with the resources of the father’s company. To facilitate a structured merger between the two companies that was to transfer most of the wealth to the younger generation with minimal tax consequences, tax advisors concocted a narrative in which the sons’ company owned the technology prior to the merger. The IRS claimed the transfer was a huge gift, and the Tax Court, although highly sympathetic to the taxpayer, agreed.

This case, Bogdanski says, is a clear win for the IRS. The service got its hands on very damning evidence related to the tax advisors. Perhaps counsel for the taxpayer should have emphasized the goodwill the younger generation created around the technology and machine. It was real.

Bross Trucking combined corporate income tax and gift tax issues. The father built a road construction empire that included a trucking company, which the taxpayer owned 100%. When it ran into serious trouble with regulators, father and sons decided to form a new company, ostensibly to ensure a clean regulatory slate. The IRS claimed the company had distributed an appreciated intangible asset to the taxpayer, who then transferred it to his sons and was liable for gift tax. The Tax Court (J. Paris again) disagreed. What the old company had was “the antithesis of goodwill.” The family built a new company precisely to avoid losing customers.

Bogdanski points out that the court seems to ignore that the customer base was made up almost entirely of other family entities, all of which were linked to the road construction business. There were no arm’s-length transactions, and it is conceivable that indirect gifts were being made regularly under the contracts existing among the various business entities. Maybe the real gift the father made was taking himself out of the trucking business, Bogdanski says.

All of the above cases are available at BVLaw. Stay tuned for a discussion of some of the other cases Bogdanski mentioned. Also, a full audio version of the webinar is available here.