People are often surprised by the long reach of Internal Revenue Service (“Service” or “IRS”) liens.¹ Plains Capital Corporation (“Plains”) recently learned this lesson. Plains lost a fight with the Service in a case before the United States District Court for the Eastern District of Texas. It appealed to Fifth Circuit Court of Appeals. Losing again, Plains proceeded with an appeal to the United States Supreme Court. Unfortunately, on June 24, 2013, the highest court in the nation refused to hear Plain’s appeal.² The saga is over for Plains, but the case should be a loud warning to others.
In 2002 and 2003, the Service assessed taxpayer Gregory Rand (“Rand”) for tax liabilities arising from 2000 and 2002. It eventually filed notices of federal tax liens totaling over $3 million (“Tax Liens”).
In 2005, Rand obtained a $200,000 line of credit from Plains. Plains was aware of the Tax Liens. To secure its credit extension, however, it took possession of the title to Rand’s 2005 Ferrari. Plains thought taking possession of the vehicle title would put it in front of the IRS. Wrong!
In 2007, Rand agreed with the IRS that he would deliver the Ferrari to Boardwalk Motor Sports, Ltd (“Boardwalk”). Boardwalk agreed to sell the vehicle on consignment.
The Service and Plains could not agree upon the priority of their respective liens. So, the IRS served a notice of levy on Boardwalk and instructed Boardwalk to deliver the sale proceeds to it. Later, an IRS agent instructed Boardwalk not to release the sale proceeds until the IRS and Plains reached agreement on lien priorities. If it was unsure whether an agreement was reached, Boardwalk was instructed to go to the local court and file an interpleader action.
Less than one month later, Boardwalk sold the Ferrari for $210,454. Boardwalk immediately attempted to contact the IRS agent to discuss what to do with the proceeds, but the agent was away on vacation. Rather than wait for the agent’s return, or pursue an interpleader action, Boardwalk inexplicably sent the net sale proceeds ($210,454 less a commission and sale costs = $194,982) to Plains and obtained the vehicle title for the buyer.
The IRS agent returned from vacation and learned of the sale. Likely irate, the agent served Boardwalk with a demand for payment of the net sales proceeds. He also served a notice of levy on Plains.
Having received no acceptable response from either Boardwalk or Plains, the Service sued both of them for failure to honor the demand and levy. It also sued them for tortious conversion. The Fifth Circuit concluded:
- The IRS had perfected its lien.
- The IRS’ lien was superior to Plain’s lien.
- Once the Ferrari was sold, the Service’s lien attached to the sale proceeds.
- Plains failed to honor the IRS’ levy.³
There are many lessons learned:
- Subsequent liens (including possession of title to a vehicle) generally do not trump a prior IRS lien.
- If unsure who has superior rights to sale proceeds, consider filing an interpleader action and let the court decide the issue.
- Do not ignore IRS liens or levies; possession of the taxpayer’s property generally will not save the day.
¹ This article is for educational purposes only and should not be relied upon as tax or legal advice.
² U.S. v. Boardwalk Motor Sports Ltd. And Plains Capital Corporation, 692 F3d (5th Cir. 2012), certiorari denied (NO. 12-1025), June 24, 2013.
³ Due to state law technicalities, the court found no conversion occurred.
Section 336(e)1 expressly delegates authority to Treasury to issue regulations, allowing taxpayers to elect to treat the sale, exchange or distribution of corporate stock as a deemed sale of the corporation’s underlying assets. On May 15, 2013, Treasury finalized regulations under Section 336(e).
What is the 336(e) Election?
A Section 336(e) election allows certain taxpayers to treat the sale, exchange or distribution of corporate stock as an asset sale. The benefit of an asset sale is obvious—the basis of the target corporation’s assets is stepped up to fair market value.
If an election is made, “old target” is treated as selling all of its assets to “new target.” New target is treated as purchasing those assets, resulting in a step-up in basis of the assets. Old target recognizes the gain or loss from the deemed asset sale immediately before the close of the stock transaction.
Section 336(e) is intended to provide taxpayers relief from multiple levels of tax on the same economic gain—economic gain attributable to the appreciation of assets held in corporate solution. Such multiple levels of tax can result from the taxable transfer of appreciated corporate stock where the assets in corporate solution do not receive a corresponding step-up in basis.
Who Can Use the 336(e) Election?
The Section 336(e) election is available if certain requirements are met:
- First, the seller (or sellers) must be a domestic corporation, a consolidated group of corporations, or an S corporation shareholder (or shareholders).
- Second, the seller must own sufficient stock in the target corporation to satisfy certain “vote and value requirements.” Under the vote and value requirements, the seller must own at least 80% of the total voting power of the target corporation’s stock and 80% of the total value of the target corporation’s stock.
- Third, within a 12-month period, the seller must sell, exchange or distribute a sufficient amount of stock to satisfy the vote and value requirements—80% of the total value and 80% of the voting power of the target stock.
Why Use a 336(e) Election Instead of the 338 Election?
A Section 338(h)(10) election also allows certain taxpayers to treat a stock sale as an asset sale, which results in a step-up in the basis of the target corporation’s assets. The final Section 336(e) regulations adopt many of the principles set forth in the Section 338(h)(10) regulations. However, there are significant differences between the Section 338(h)(10) regulations and the final Section 336(e) regulations, including:
- Unlike a Section 338(h)(10) election, Section 336(e) does not require the acquirer of the stock to be a corporation (or even a purchaser). This critical difference allows the corporation to be converted to a flow-through entity after the acquisition.
- While a Section 338(h)(10) election generally requires a single purchasing corporation acquire the target stock, a Section 336(e) election allows the taxpayer to aggregate all target stock sold, exchanged or distributed to different acquirers when determining whether the vote and value requirements are met.
- Unlike a Section 338(h)(10) election, a Section 336(e) election is unilaterally made by the seller attaching a statement to its Federal tax return for the year of the acquisition.
- A Section 336(e) election is available in certain spin-off transactions under Section 355.
Section 336(e) offers many planning opportunities. It allows a deemed asset sale in many situations where an election under Section 338(h)(10) is unavailable. It is an important tool to consider when planning and negotiating a corporate acquisition. Because of the dramatic shift in tax liability resulting from a Section 336(e) election, it is necessary to understand the tax implications and to have the proper agreements in place before making the election.
Larry J. Brant is a Shareholder in Garvey Schubert Barer, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; New York, New York; Washington, D.C.; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," New York University Tax Conferences in July – Advanced Conference on Subchapter SNew York NY, 7.25.19
- "Tax Law Update for Family Law Practitioners," Oregon State Bar - Family Law Section 2019 Annual ConferenceSunriver, OR, 10.10.19-10.12.19
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," New York University 78th Institute on Federal TaxationNew York, NY, 10.20.19-10.25.19
- "Subchapter S After the Tax Cuts and Jobs Act – the Good, the Bad and the Ugly," Oregon Society of Certified Public Accountants (OSCPA) 2019 Northwest Federal Tax ConferencePortland, OR, 10.28.19
- "The Road Between Subchapter C and Subchapter S – It May Be a Well-Traveled Two-Way Thoroughfare, but It Isn’t Free of Potholes and Obstacles," New York University 78th Institute on Federal TaxationSan Francisco, CA, 11.10.19–11.15.19