Academic journal article Journal of Accountancy

Tax Shelter Can Have Business Purpose

Academic journal article Journal of Accountancy

Tax Shelter Can Have Business Purpose

Article excerpt

The IRS has been developing policies to attack a variety of tax shelters including the contingent liability shelter, in which a high-basis asset is transferred to a new corporation in exchange for stock in an IRC section 351 transaction. The transferred asset is accompanied by a contingent liability--a liability that the transferor has not yet been able to recognize for tax purposes. Consequently, the stock received has a high basis though its value is low because of the contingent liability, and selling it results in a loss. In notice 2001-17 (2001-1 CB 730) the IRS announced it would disallow losses claimed from contingent liability transactions.

Black & Decker created Black & Decker Healthcare Management Inc. (BDHMI) by transferring $561 million to the newly formed corporation. BDHMI assumed a $560 million contingent liability for health care claims; its resulting value was $1 million ($561 million less $560 million). Black & Decker then sold the BDHMI stock for $1 million and claimed a capital loss of $560 million ($1 million less $561 million), which it used to offset capital gains from the sale of three of its businesses. The IRS disallowed the loss. Black & Decker sued for a refund.

Result. For the taxpayer. The District Court of Maryland (Northern Division), issued a summary judgment holding that the BDHMI transaction had economic substance and therefore must be acknowledged. Pointing out that a sham transaction can be ignored for tax purposes as discussed in Hunt (938 F2d 466,471 (4th Cir. 1991)), the court reiterated the definition of a sham transaction as one designed solely to create tax benefits rather than to serve a legitimate business purpose. …

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