Jason B. Sage v. Commissioner , 154 T.C. No. 12 ( 2020 )

154 T.C. No. 12UNITED STATES TAX COURT
JASON B. SAGE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3372-16. Filed June 2, 2020.
P, a real estate developer, owned through subchapter S
corporation IDG three parcels of Oregon real estate encumbered by
liabilities in excess of their fair market values. In response to the
2008 economic recession, IDG engaged in a series of transactions in
December 2009 designed to transfer the parcels to three separate
liquidating trusts for the benefit of the mortgage holders. Between
2010 and 2012 the liquidating trusts disposed of the parcels, and the
mortgage holders applied the proceeds from these dispositions against
the outstanding liabilities of IDG and its wholly owned limited
liability company (LLC).
IDG reported significant losses as a result of the 2009
transactions, which losses P claimed on his 2009 individual tax
return. These losses gave rise to a net operating loss (NOL), which P,
inter alia, carried back to his 2006 taxable year as an NOL carryback
deduction and forward to his 2012 taxable year as an NOL carryover
deduction. R disallowed the losses reported by IDG and claimed by P
for the 2009 taxable year, made correlative adjustments to the 2006
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and 2012 NOL deductions, and determined deficiencies for 2006 and
2012.
Held: As the proceeds of the Oregon parcels held by the
liquidating trusts were applied to discharge certain liabilities of IDG
and its wholly owned LLC between 2010 and 2012, IDG and the LLC
were the owners of the corresponding liquidating trusts during those
respective years pursuant to the “grantor trust” provisions. I.R.C.
secs. 671-679.
Held, further, because IDG and the LLC owned the liquidating
trusts beyond the close of the 2009 taxable year, the losses reported
by IDG and claimed by P for 2009 were not bona fide dispositions
and not “evidenced by closed and completed transactions, fixed by
identifiable events, and * * * actually sustained during” that year.
Sec. 1.165-1(b), Income Tax Regs. The deductions were properly
disallowed.
Craig R. Berne, Milton R. Christensen, and Dan Eller, for petitioner.
Nhi T. Luu, Kelley A. Blaine, and Janice B. Geier, for respondent.
URDA, Judge: In 2009 petitioner, Jason B. Sage, an Oregon real estate
developer, found himself significantly under water with respect to three parcels of
land that he indirectly owned through his wholly owned companies--that is, he
owed much more to his mortgage lenders than the land was worth. Facing these
financial straits, Mr. Sage undertook a series of transactions to transfer the parcels
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from his companies into liquidating trusts established for the benefit of his
respective lenders.
Mr. Sage claimed ordinary losses from these transactions on his 2009
Federal income tax return, giving rise to a large net operating loss (NOL) for that
year. He applied a portion of the NOL to his 2006 taxable year as an NOL
carryback deduction and a portion to his 2012 taxable year as an NOL carryover
deduction. The Internal Revenue Service (IRS) disallowed the loss claimed for
2009--thus reducing the NOL amount available to be carried to 2006 and 2012--
and determined deficiencies of $1,468,264 and $7,701 for those respective years.1
It also determined an accuracy-related penalty for 2012.
Before this Court the parties dispute whether the transfers of the parcels to
the liquidating trusts had the effect of producing the 2009 loss claimed by Mr.
Sage. We conclude that they did not and will sustain the IRS’ determinations.
1
Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the years at issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure. All amounts are rounded to the
nearest dollar.
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FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulations of
facts and the attached exhibits are incorporated by this reference. Mr. Sage
resided in Oregon when he timely filed his petition.
I. Mr. Sage’s Real Estate Business
A. Business Overview and 2007 Loans
During the periods relevant to this case Mr. Sage was a real estate developer
operating a number of vertically integrated companies that, inter alia, purchased
raw land, developed lots and subdivisions, constructed homes, and sold (or rented)
the developed properties. Among other entities, Mr. Sage owned Integrity
Development Group, Inc. (IDG), a subchapter S corporation in the business of
buying raw land and developing it into finished lots. By 2007 IDG had acquired
three parcels of real property outside of Portland, Oregon: (1) the Village at
Summer Creek (Village); (2) the North Plains Sunset Terrace (Plains); and
(3) Gales Creek (Creek), which IDG owned through Gales Creek Terrace LLC, a
single-member limited liability company that elected to be disregarded as an entity
for Federal tax purposes.
During 2007 IDG took out loans of $6,160,000 and $5,060,000 from
Sterling Savings Bank (Sterling), which were secured by Village and Plains,
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respectively. Mr. Sage executed indemnification agreements relating to both loans
as president of IDG, president of JLS Custom Homes, Inc. (another of Mr. Sage’s
wholly owned businesses), and on his own behalf.
The same year Gales Creek Terrace LLC took out a line of credit of
$7,100,000 from Community Financial Corp. (CFC), secured by Creek. Two
years earlier Mr. Sage had executed a personal guaranty agreement with CFC by
which he unconditionally guaranteed payment to CFC of all obligations that Gales
Creek Terrace LLC owed at that time or would incur in the future.
B. Worsening Economic Conditions
The national economic downturn reached Oregon soon thereafter, and Mr.
Sage’s real estate business was hit hard. Mr. Sage took a variety of actions to stay
afloat, including cutting staff and overhead, renegotiating prices with
subcontractors, slowing down construction, and putting his own money back into
the companies.
Mr. Sage also negotiated with, and sought accommodation from, his
lenders. He entered into two forbearance agreements with Sterling, as well as a
settlement agreement releasing him from his personal obligations as guarantor for
the Sterling loans in exchange for an upfront payment of $750,000 and a
promissory note for another $750,000. In addition he engaged in discussions with
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CFC about the financial headwinds he faced, his attempts to keep his businesses
afloat, and different strategies moving forward.
II. Liquidating Trust Transactions
One strategy that Mr. Sage and his advisers developed during this time
involved the transfer of parcels of real property into separate liquidating trusts,
with each parcel’s creditor named as the beneficiary of the associated trust.2 Mr.
Sage believed that this arrangement offered advantages both for his creditors and
for himself. Specifically, Mr. Sage (and colleagues) touted that this strategy
would protect his creditors’ interests in the case of an involuntary bankruptcy. For
himself, Mr. Sage saw a tax benefit.
By late 2009 Village, Plains, and Creek were worth significantly less than
the liabilities they secured. Mr. Sage therefore decided to pursue his liquidating
trust strategy in connection with these parcels. He did not consult with either
Sterling or CFC before electing to do so.
2
As discussed in greater depth below, liquidating trusts are entities
recognized as “trusts” for Federal tax purposes. See sec. 301.7701-4(d), Proced.
& Admin. Regs. The regulations provide that, subject to certain other
requirements: “An organization will be considered a liquidating trust if it is
organized for the primary purpose of liquidating and distributing the assets
transferred to it, and if its activities are all reasonably necessary to, and consistent
with, the accomplishment of that purpose.” Id.-7-
To implement the liquidating trust strategy, IDG first organized three so-
called project LLCs under Oregon State law: the Village Project LLC (Village
Project LLC), the North Plains Project LLC (Plains Project LLC), and the Gales
Creek Terrace Project LLC (Creek Project LLC).3 Each project LLC, having IDG
as its sole member, elected to be disregarded for Federal tax purposes. On
December 28, 2009, IDG transferred (by statutory bargain and sale deeds) Village
and Plains to the correspondingly named project LLCs for a stated consideration
of zero. Gales Creek Terrace LLC made a similar transfer of Creek the same day
for the same consideration (zero). The deeds were recorded on December 31,
2009.
Also on December 31, 2009, JLS Property Management LLC (JLS)4
established three trusts under Oregon law to house the newly created project
LLCs: the Village Project Liquidating Trust (Village Trust), the North Plains
3
The articles of organization for the Village Project LLC were filed with the
Oregon Secretary of State on December 18, 2009, and the articles for the Plains
Project LLC and the Creek Project LLC were filed on December 29, 2009. The
operating agreements for each of the project LLCs were executed on December
31, 2009.
4
JLS, another of Mr. Sage’s companies, was wholly owned by JLS Custom
Homes, Inc.
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Project Liquidating Trust (Plains Trust), and the Gales Creek Terrace Project
Liquidating Trust (Creek Trust). JLS was appointed sole trustee of all three trusts.
Each of the trust instruments initially identified “Indymac Federal Bank” as
the beneficiary.5 On the same day (December 31) one of Mr. Sage’s associates,
Ron Winter, informed Sterling by both email (time-stamped 4:52 p.m.) and letter
that Mr. Sage had established the Village Trust and the Plains Trust for Sterling’s
benefit and requested a meeting to “go over th[ese] transaction[s] so the bank
understands what we did, and how we are going to proceed from here.”6 He sent a
similar notice to CFC on December 31 regarding the establishment of the Creek
Trust. The trust instruments were later revised to designate Sterling as the
beneficiary of the Village Trust and the Plains Trust and CFC as the beneficiary of
the Creek Trust.
The governing instrument of each trust specified that it was intended to
qualify as a liquidating trust within the meaning of section 301.7701-4(d), Proced.
5
In addition to incorrectly identifying its beneficiary, the Creek Trust
instrument incorrectly stated that IDG had deeded real property to the Creek
Project LLC. Gales Creek Terrace LLC, not IDG, deeded Creek to the Creek
Project LLC.
6
A Sterling employee responded to Mr. Winter’s message by email on the
morning of January 4, 2010, stating that “ownership changes do not absolve the
guarantors of their obligations under the loan documents”.
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& Admin. Regs. The trust documents further provided that the trusts had been
established for the sole purpose of liquidating the assets transferred to them for the
benefit of the creditor-beneficiary, and that they had no objective or authority to
pursue any trade or business activity beyond what was necessary to accomplish
that purpose.
Against this backdrop the trust instruments recited that IDG would transfer
ownership of the project LLCs to the trusts for the purpose of liquidating Village,
Plains, and Creek for the benefit of Sterling (in the case of the Village Trust and
the Plains Trust) and CFC (in the case of the Creek Trust). They further specified
that the parties to each trust would “treat” the foregoing transfer for Federal tax
purposes as (1) first a transfer by IDG of the respective project LLC membership
units to the creditor-beneficiary (i.e., Sterling or CFC), immediately followed by
(2) a transfer by that creditor-beneficiary of the membership units to the respective
trust in exchange for a beneficial interest in that trust.
On the same day the trusts were established (that is, December 31, 2009),
IDG transferred its ownership of the project LLCs to the trusts. IDG did not
receive any consideration, whether in the form of cash, property, or relief from
indebtedness, for these transfers. Each project LLC’s operating agreement was
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accordingly amended to substitute the corresponding trust for IDG as the project
LLC’s sole member.
The end result of these transactions was that Village, Plains, and Creek were
each held by the respectively named trusts. Despite the ownership changes IDG
and Gales Creek Terrace LLC remained liable to Sterling and CFC under the
respective loans. In applying for an exemption from a county transfer tax relating
to Village, Mr. Sage stated that the property was “not being sold, but simply
transferred to another wholly owned entity” with “no transfer of debt”, in order to
“create a liability protection entity”.
III. Subsequent Dispositions of the Properties
After the 2009 transactions, Mr. Sage and his companies continued to
manage and market Village, Plains, and Creek. After 2009 IDG did not retain the
properties as assets on its books but reported the remaining unsatisfied loan
balances as liabilities on its financial reports. Village was sold in 2010 for
$3,469,390, while Plains was sold in 2012 for $350,000. The net proceeds from
these sales were then distributed to Sterling, which in turn credited the distributed
amounts against IDG’s outstanding loans.
Things went differently with Creek. For a time the Creek Trust collected
and reported rental income from the property. But in February of 2010 CFC
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issued a demand letter to Gales Creek Terrace LLC (and to Mr. Sage as guarantor),
which led to negotiations between Mr. Sage and CFC’s president. These
discussions spilled over into 2011, culminating in a “workout and shortfall
agreement”, executed on April 6, 2011, under which Mr. Sage (in his personal
capacity and as president of IDG, the sole member of Gales Creek Terrace LLC)
agreed to (1) transfer $200,000 in cash along with a promissory note for an
additional $400,000 to CFC and (2) cause Creek Project LLC to transfer Creek to
CFC by deed in lieu of foreclosure in exchange for settlement of Gales Creek
Terrace LLC’s CFC debt.7
IV. 2009 Tax Returns and IRS Examination
IDG filed a Form 1120S, U.S. Income Tax Return for an S Corporation, for
its 2009 taxable year. On that return IDG reported ordinary losses stemming from
the transfers of Village, Plains, and Creek to the trusts of $5,450,154, $1,105,956,
and $2,574,470, respectively.8 In total (from these and other transactions) IDG
7
The deed in lieu of foreclosure attached to the workout agreement was
signed by Mr. Sage in his capacity as president of IDG. Although the deed
reflected that IDG was a member of the Creek Project LLC, IDG had previously
transferred its membership units in that entity to the Creek Trust on December 31,
2009.
8
These sums represent IDG’s calculation of the difference between its
adjusted tax bases in Village, Plains, and Creek (of $7,914,154, $1,605,956, and
(continued...)
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reported an ordinary business loss of $8,061,293 in the Schedule K-1,
Shareholder’s Share of Income, Deductions, Credits, etc., included with its 2009
return. Pursuant to section 1366, IDG’s ordinary loss flowed through to Mr. Sage.
On Mr. Sage’s 2009 Form 1040, U.S. Individual Income Tax Return, he
claimed a total nonpassive loss of $10,489,926 flowing through to his return from
his various companies. Of that sum, $5,310,826 was attributable to IDG.9 The
losses claimed on Mr. Sage’s 2009 return gave rise to an NOL, which he carried
back to prior years, including his 2006 taxable year, as well as forward to future
years, including his 2012 taxable year. The NOL carried back to 2006 and
forward to subsequent years resulted in significant refunds, which Mr. Sage used
to pay off debts and interest due on various loans owed by his companies.
The IRS examined the returns filed by Mr. Sage and IDG for 2009 and
determined that the losses reported by IDG (and claimed by Mr. Sage) for that year
with respect to the trust transactions should be disallowed because they were
8
(...continued)
$3,169,041, respectively) on December 31, 2009, and its estimates of the fair
market values of those properties (of $2,464,000, $500,000, and $594,571,
respectively) as of that date.
9
Although IDG reported ordinary business losses of $8,061,293 on its 2009
return, sec. 1366(d)(1) limited the “aggregate amount of losses and deductions”
that Mr. Sage could take into account to the sum of (1) the adjusted basis of his
stock in IDG and (2) his adjusted basis in any indebtedness of IDG to him.
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“attributable solely to nonbusiness expenses” of IDG. That disallowance
significantly reduced Mr. Sage’s allowable NOL amount for 2009--the basis for
his 2006 and 2012 NOL deductions.
The IRS subsequently issued to Mr. Sage two statutory notices of deficiency
consistent with the foregoing determinations. As relevant to the instant case, the
first notice, dated November 12, 2015, determined an income tax deficiency of
$1,468,264 for 2006. The second, dated December 22, 2015, determined an
income tax deficiency of $7,701 and an accuracy-related penalty for an
underpayment of tax attributable to a substantial understatement of income tax
under section 6662(a) and (b)(2) of $1,540 for 2012.10
Mr. Sage filed a timely petition in this Court seeking redetermination of the
deficiencies and penalty set forth in the notices of deficiency.
OPINION
In general, a taxpayer seeking to challenge the IRS’ determinations in a
notice of deficiency bears the burden of proving those determinations incorrect.
Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). The Commissioner
10
The immediate supervisor of the revenue agent who made the initial
determination to assert the sec. 6662 penalty against Mr. Sage for his 2012 taxable
year signed an approval form with respect to that penalty before the issuance of
the December 2015 notice of deficiency.
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bears the burden of proof, however, with respect to any “new matter” he raises.
See Rule 142(a)(1). He will be considered to have raised a new matter when the
basis or theory upon which he relies was not stated in the notice of deficiency and
the new theory or basis requires the presentation of different evidence. Shea v.
Commissioner, 112 T.C. 183, 197 (1999).
Respondent concedes on brief that he has raised a new matter that was not
laid out in either notice of deficiency issued to Mr. Sage. Specifically the notice
of deficiency for 2006 indicates that the IRS disallowed the underlying loss on the
ground that it “was attributable solely to nonbusiness expenses.” At trial and in
his briefs, however, respondent asserted a new theory for the disallowance of
IDG’s loss: namely, that the 2009 trust transactions were not “closed and
completed transactions” capable of producing realizable losses for that year. He
accordingly bears the burden of proof with respect to the deficiencies determined
for Mr. Sage’s 2006 and 2012 taxable years.11
11
Respondent also has conceded, in light of a revised report prepared by one
of his revenue agents, that the income tax deficiency determined for Mr. Sage’s
2006 taxable year should instead be $1,414,176. For his part, Mr. Sage concedes
that if we hold for respondent on the loss issue, he will be liable for the accuracy-
related penalty.
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I. Preliminary Matters
A. Evidentiary Rulings
At trial and in his briefs Mr. Sage objected to 12 proposed exhibits (Exhibits
21-R and 24-R through 34-R), as well as paragraph 93 of the stipulation. Mr.
Sage objected on the ground of relevance to each and also asserted that certain of
the exhibits (Exhibits 33-R and 34-R) and the stipulation paragraph constituted
improper expert testimony. Mr. Sage further objected to Exhibits 21-R and 32-R
on hearsay grounds.
We first turn to relevance. Tax Court proceedings are conducted in
accordance with the Federal Rules of Evidence. See sec. 7453; Rule 143. Rule
401 of those rules provides that “[e]vidence is relevant if: (a) it has any tendency
to make a fact more or less probable than it would be without the evidence; and
(b) the fact is of consequence in determining the action.” The relevance bar is a
low one. See, e.g., Crawford v. City of Bakersfield, 944 F.3d 1070, 1077 (9th
Cir. 2019); United States v. Durham, 902 F.3d 1180, 1225 (10th Cir. 2018); CNT
Inv’rs, LLC v. Commissioner, 144 T.C. 161, 191 n.32 (2015); see also Daubert v.
Merrell Dow Pharms., Inc., 509 U.S. 579, 587 (1993).
We will overrule all of Mr. Sage’s relevance objections, except his
objection to Exhibit 33-R. Exhibit 21-R details the status of the CFC loan
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(relating to Creek) in September 2009, thus providing insight into the financial
state of that property shortly before the liquidating trust transactions. Exhibits
24-R through 32-R relate to previous liquidating trust transactions by Mr. Sage,
which supply context for the transactions at issue. Exhibit 34-R likewise provides
relevant information regarding Sterling’s dealings with Mr. Sage before he put his
liquidating trust transactions into motion. And the stipulation paragraph relates to
the ultimate disposition of trust assets by sale, which is very relevant to our
analysis. We conclude, however, that Exhibit 33-R is not relevant as it relates
exclusively to Sterling’s internal view of a 2008 transaction and has no bearing on
2009.
We will also overrule Mr. Sage’s objection that Exhibit 34-R and stipulation
paragraph 93 constitute improper expert testimony. Exhibit 34-R contains notes
summarizing Sterling’s view of its business with Mr. Sage in 2009, and we will
accept it as such. And we see no improper expert testimony in the stipulation
paragraph, which merely states that Sterling applied the proceeds of the sale of
Plains against IDG’s loan and that the loan has yet to be fully paid.
Finally, we will overrule Mr. Sage’s hearsay objections. Exhibit 21-R is not
accepted for the truth of the representations therein but simply to illustrate CFC’s
view of the Creek loan before Mr. Sage decided to implement the liquidating trust
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transaction. Likewise Exhibit 32-R provides context for Mr. Sage’s actions in
2009, and we accept it for that limited reason.
B. Loss and NOL Deductions
Section 165(a) permits a deduction for “any loss sustained during the
taxable year and not compensated for by insurance or otherwise.” To be allowable
as a deduction under section 165(a), “a loss must be evidenced by closed and
completed transactions, fixed by identifiable events, and * * * actually sustained
during the taxable year.” Sec. 1.165-1(b), Income Tax Regs. “In most cases a
‘closed and completed transaction[]’ will occur upon a sale or other disposition of
property”, although this requirement may be satisfied in some instances “if the
taxpayer abandons an asset or the asset becomes worthless.” Tucker v.
Commissioner, T.C. Memo. 2015-185, at *10-*11 (alteration in original), aff’d,
841 F.3d 1241 (11th Cir. 2016). The year for which a taxpayer can claim a loss
deduction evidenced by a closed and completed transaction is a question of fact.
Forlizzo v. Commissioner, T.C. Memo. 2018-137, at *8; see Boehm v.
Commissioner, 326 U.S. 287, 293 (1945).
Section 1.165-1(b), Income Tax Regs., further specifies that “[o]nly a bona
fide loss is allowable.” In determining the deductibility of a loss, “[s]ubstance and
not mere form shall govern”. Id. These requirements call for a practical test,
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rather than a legal one, and turn on the particular facts of each case. Boehm v.
Commissioner, 326 U.S. at 293; Lucas v. Am. Code Co., 280 U.S. 445, 449
(1930); Ence v. Commissioner, T.C. Memo. 2018-151, at *5.
Where the deductions allowed to a taxpayer for a given year exceed his
gross income for that year, the taxpayer has an NOL as defined by section 172(c).
Generally, section 172(b)(1)(A) permits a taxpayer to apply an NOL to other
taxable years by first carrying back the NOL to the two taxable years preceding the
year in which the NOL was generated and then by carrying over any unused
portion of the NOL to the 20 years that follow. For taxable years ending after
December 31, 2007, and beginning before January 1, 2010, the carryback period
for certain NOLs was increased to three, four, or five years. Sec. 172(b)(1)(H).12
Section 172(a) provides for an NOL deduction for a given year equaling the
aggregate of a taxpayer’s NOL carryovers and his NOL carrybacks.
Mr. Sage asserts that IDG is entitled to a deduction under section 165 (from
which the 2006 and 2012 NOL deductions at issue derive) because the transfers of
12
The Worker, Homeownership, and Business Assistance Act of 2009, Pub.
L. No. 111-92, sec. 13(a), 123 Stat. at 2992, “amended sec. 172(b)(1)(H)(i) to
permit a taxpayer to elect to carry back a net operating loss for the 2009 tax year to
three, four, or five years instead of the usual two years.” Tucker v. Commissioner,
T.C. Memo. 2015-185, at *8 n.5, aff’d, 841 F.3d 1241 (11th Cir. 2016). The
beneficial treatment extended to 2009 NOLs provides perspective into the flurry of
activity by Mr. Sage’s companies in late December 2009.
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Village, Plains, and Creek to the trusts for the benefit of the lenders were bona fide
dispositions of property that generated actual losses. Mr. Sage’s argument hinges
on the nature of the relationship between IDG (or Gales Creek Terrace LLC in the
case of Creek) and the respective liquidating trust and implicates the Code’s
“grantor trust” provisions, sections 671 through 679.13
II. Characterization of the Trusts
A. Governing Framework
Section 671 provides that where a grantor of a trust or another person is
treated as the owner of any portion of a trust, “there shall then be included in
computing [its] * * * taxable income and credits * * * those items of income,
deductions, and credits against tax of the trust which are attributable to that
portion of the trust to the extent that such items would be taken into account under
this chapter in computing taxable income or credits against the tax of an
individual.” The “grantor of a trust is treated as the owner of that trust if certain
conditions specified in” sections 673 through 678 exist.14 Holman v. United
13
We assume for the purposes of the instant analysis that the Village Trust,
the Plains Trust, and the Creek Trust each qualifies as a trust under Oregon law.
We do not address respondent’s State law arguments attacking the validity of the
trusts.
14
The term “grantor” includes any party that creates a trust or directly (or
(continued...)
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States, 728 F.2d 462, 464 (10th Cir. 1984); see also Gould v. Commissioner, 139
T.C. 418, 435 (2012), aff’d, 552 F. App’x 250 (4th Cir. 2014). These “grantor
trust” provisions enunciate “rules to be applied where, in described circumstances,
a grantor has transferred property to a trust but has not parted with complete
dominion and control over the property or the income which it produces.” Scheft
v. Commissioner, 59 T.C. 428, 430 (1972) (fn. ref. omitted); see also Gould v.
Commissioner, 139 T.C. at 435; Wesenberg v. Commissioner, 69 T.C. 1005, 1012
(1978); Rahall v. Commissioner, T.C. Memo. 2011-101, 101 T.C.M. (CCH) 1486,
1490-1491 (2011).15 Although several of the grantor trust rules are framed in
terms of trust “income”, section 1.671-2(b), Income Tax Regs., clarifies that “it is
ordinarily immaterial whether the income involved constitutes income or corpus
14
(...continued)
indirectly) makes a gratuitous transfer--that is, a transfer other than for fair market
value--of property to the trust. Sec. 1.671-2(e)(1) and (2)(i), Income Tax Regs. A
partnership or a corporation making a gratuitous transfer to a trust for a business
purpose of that partnership or corporation will also be a grantor of the trust. Id.subpara. (4).
15
Application of the grantor provisions does not preclude the
Commissioner’s use of sham trust theories, the reciprocal-trust doctrine, or
assignment of income principles. See, e.g., Markosian v. Commissioner, 73 T.C.
1235, 1244-1245 (1980); Krause v. Commissioner, 57 T.C. 890, 901 (1972), aff’d,
497 F.2d 1109 (6th Cir. 1974); Snyder v. Commissioner, T.C. Memo. 2001-255,
82 T.C.M. (CCH) 651, 658 (2001). Respondent has chosen not to pursue those
theories in this case, however.
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for trust accounting purposes” in light of the general objectives of the grantor trust
rules. Cf. Madorin v. Commissioner, 84 T.C. 667, 677-678 (1985) (noting that the
attribution of ownership under the grantor trust scheme may extend to both trust
income and trust corpus).
“The grantor trust provisions can be viewed as a series of obstacles, each
with conditions that can cause a grantor to be treated as owner of trust property.”
Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates and
Gifts, para. 80.1.1, at 80-8 (3d ed. 2003). These provisions apply if their
conditions are met, regardless of the existence of a bona fide nontax reason for
creating the trust. Luman v. Commissioner, 79 T.C. 846, 853 (1982).
As most relevant here, section 677(a)(1) considers a grantor the owner of
any portion of a trust “whose income without the approval or consent of any
adverse party is, or, in the discretion of the grantor or a nonadverse party, or both,
may be” distributed to him or his spouse.16 Section 677(a) generally encompasses
16
An “adverse party” is any person who has “a substantial beneficial interest
in the trust which would be adversely affected by the exercise or nonexercise of
the power which he possesses respecting the trust.” Sec. 672(a). The term
“nonadverse party” refers to any person that is not an “adverse party”. Sec.
672(b). Adversity is a question of fact determined in each case by reference to the
particular interest created by the trust instrument. See Vercio v. Commissioner, 73
T.C. 1246, 1256-1257 (1980); Paxton v. Commissioner, 57 T.C. 627, 631 (1972),
aff’d, 520 F.2d 923 (9th Cir. 1975).
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the portion of any trust “whose income is, or in the discretion of the grantor or a
nonadverse party, or both, may be applied in discharge of a legal obligation of the
grantor”. Sec. 1.677(a)-1(d), Income Tax Regs.
This Court has held that an “owner” under the grantor trust scheme is an
owner in the usual, ordinary, and everyday sense of the word. Madorin v.
Commissioner, 84 T.C. at 671. In so holding we observed that while “[s]ection
671 specifies one result of being an ‘owner,’ * * * it does not specifically limit the
meaning to that result.” Id. at 672. And because ownership under the grantor trust
regime results in the attribution of income directly to the owner, “the Code, in
effect, disregards the trust entity.” Id. at 675. Consequently, if a trust grantor is
deemed an owner, the trust “is not treated as a separate taxable entity for Federal
income tax purposes to the extent of the grantor’s retained interest.” Gould v.
Commissioner, 139 T.C. at 435. To put it another way, when the grantor trust
provisions apply, they function to “look through” the trust form and ignore the
“owned” portion of the trust for Federal tax purposes as existing separately from
the grantor. See Madorin v. Commissioner, 84 T.C. at 671; Estate of O’Connor v.
Commissioner, 69 T.C. 165, 174 (1977); see also Reddam v. Commissioner, 755
F.3d 1051, 1055 n.5 (9th Cir. 2014), aff’g T.C. Memo. 2012-106; Samueli v.
Commissioner, 661 F.3d 399, 403 n.4 (9th Cir. 2011), aff’g in part, remanding in
- 23 -
part 132 T.C. 37 (2009); First Chi. NBD Corp. v. Commissioner, 135 F.3d 457,
460 (7th Cir. 1998), aff’g 96 T.C. 421 (1991).
B. Analysis
Under the specific facts of this case, section 677(a)(1) and its accompanying
regulations compel the conclusions that (1) IDG was the owner of Village and
Plains in 2010 and 2012, respectively, and Gales Creek Terrace LLC was the
owner of Creek in 2011, and (2) the Village Trust and the Plains Trust were not
separate taxable entities from IDG, and the Creek Trust was not a separate taxable
entity from Gales Creek Terrace LLC, during those years. These twin conclusions
preclude the tax treatment Mr. Sage seeks.
As an initial matter, IDG and Gales Creek Terrace LLC were grantors of the
respective trusts. IDG was a grantor of the Village Trust and the Plains Trust by
virtue of its direct gratuitous transfer of ownership of the project LLCs (which in
turn held the properties) to the trusts. Sec. 1.671-2(e)(1), Income Tax Regs. For
its part Gales Creek Terrace LLC was a grantor of the Creek Trust because of its
indirect gratuitous transfer of Creek to the Creek Trust (through its contribution of
Creek to the Creek Project LLC). See id.As explained above, the grantor of a trust is treated as an owner where, inter
alia, trust income is “applied in discharge of a legal obligation of the grantor”.
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Sec. 1.677(a)-1(d), Income Tax Regs. Income, in this regard, includes the trust
corpus. Sec. 1.671-2(b), Income Tax Regs.
The parties before us agree that IDG and Gales Creek Terrace LLC
remained liable to Sterling and CFC, respectively, for the loans secured by
Village, Plains, and Creek after the ownership of those properties had passed to
the respective trusts. When Village was sold in 2010 for $3,469,390 and Plains
was sold in 2012 for $350,000, the proceeds were distributed to Sterling, which
credited the amounts against IDG’s outstanding loans secured by those respective
properties. For its part, Creek was transferred to CFC in 2011 in partial
satisfaction of Gales Creek Terrace LLC’s loan.
As the corpus of each trust was used to satisfy the legal obligations of IDG
or Gales Creek Terrace LLC, we conclude that they were owners of the respective
trusts after 2009, and that the trusts therefore were not separate taxable entities as
to them. See sec. 1.677(a)-1(d), Income Tax Regs.; see also Gould v.
Commissioner, 139 T.C. at 435; Madorin v. Commissioner, 84 T.C. at 671. The
2009 transfers accordingly did not accomplish bona fide dispositions of the
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property evidenced by closed and completed transactions as necessary to support
the losses ultimately reported by IDG and passed on to Mr. Sage.17
C. Mr. Sage’s Contentions
Mr. Sage counters that the application of the grantor trust provisions in this
case requires that Sterling and CFC be considered the owners of the respective
trusts, not IDG and Gales Creek Terrace LLC. He first argues that this result is
required by the nature of a liquidating trust.18 In a slightly different vein he also
17
In his briefs Mr. Sage argues that the lenders had no legal obligation to
apply any income realized from the properties to satisfy the debt of IDG or Gales
Creek Terrace LLC. This point is of no moment given that the trust corpus was
used in fact to pay these obligations. Even setting aside that fact and, further,
assuming arguendo that the lenders had discretion as Mr. Sage suggests, the trusts
nonetheless would constitute grantor trusts because they were trusts “whose
income * * *, in the discretion of * * * a nonadverse party * * * may be applied in
discharge of a legal obligation of the grantor”. Sec. 1.677(a)-1(d), Income Tax
Regs. (emphasis added). The respective trust documents require the distribution
of all net trust income and all net proceeds from the sale of trust assets to Sterling
and CFC. Although trust beneficiaries are ordinarily considered adverse parties,
sec. 1.672(a)-1(b), Income Tax Regs., a party “can hardly be considered adverse
regarding distributions for * * * [its] benefit”, Luman v. Commissioner, 79 T.C.
846, 854 (1982); see also Vercio v. Commissioner, 73 T.C. at 1258. Sterling and
CFC, two nonadverse parties, had unfettered discretion to apply trust income and
sale proceeds to satisfy the legal obligations of IDG and Gales Creek Terrace
LLC. Of course that is precisely what the lenders did.
18
Assuming that the trusts at issue here qualify as trusts under Oregon law,
we conclude that they were “liquidating trusts” within the meaning of sec.
301.7701-4(d), Proced. & Admin. Regs. The express terms of each trust
instrument comported with the requirements of that regulation, the record reflects
(continued...)
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contends that section 1.671-2(e)(3), Income Tax Regs., should be read to mean
that Sterling and CFC were owners of the respective trusts by virtue of their status
as trust beneficiaries. We find neither argument persuasive.
1. Liquidating Trust Argument
Mr. Sage contends that the nature of liquidating trusts compels the
conclusion that Sterling and CFC were the true owners of the respective trusts
beginning in 2009. Mr. Sage asserts that the creation of the liquidating trusts here
implicitly involved two steps: (1) the transfer of property from IDG to Sterling or
CFC and (2) the transfer of property from Sterling or CFC to the respective trust.
According to Mr. Sage, the first step is tantamount to a sale, and IDG should be
able to recognize a loss equaling the difference between IDG’s adjusted basis in
the respective piece of property and its fair market value--as unilaterally
determined by Mr. Sage, apparently--on December 31, 2009.
This argument has no foundation in either the Code or the applicable
regulations. As an initial matter the Code does not specifically address liquidating
trusts whatsoever and thus provides no support for Mr. Sage’s view.
18
(...continued)
that the trusts abided by those requirements, and respondent has not meaningfully
contested their treatment as such.
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Nor do the applicable regulations. Section 301.7701-4(d), Proced. &
Admin. Regs., defines a liquidating trust as “organized for the primary purpose of
liquidating and distributing the assets transferred to it,” with all activities
“reasonably necessary to, and consistent with, the accomplishment of that
purpose.” Paragraph (d) further specifies that such liquidating trusts “are treated
as trusts for purposes of the Internal Revenue Code.” Id. The regulations, like the
Code, offer no hint that liquidating trusts incorporate an implicit two-step structure
or that they provide a safe harbor from the normal operation of the grantor trust
rules.
Mr. Sage places his hopes in IRS administrative guidance that addresses
certain liquidating trust arrangements. This administrative guidance, however,
does not weigh in favor of Mr. Sage’s view of liquidating trusts.19
Mr. Sage principally relies on a 2001 Chief Counsel Advisory (CCA),
200149006, 2001 WL 1559018 (Dec. 7, 2001), which sets forth the
Commissioner’s views on a proposed chapter 11 bankruptcy plan. The plan
19
As will be discussed, Mr. Sage relies on a Chief Counsel Advisory
memorandum and certain revenue rulings. This type of memorandum is non-
precedential but may provide some insight into IRS policy. See Hulett v.
Commissioner, 150 T.C. 60, 86 n.21 (2018), appeal filed (8th Cir. Oct. 19, 2018);
Dover Corp. & Subs. v. Commissioner, 122 T.C. 324, 341 n.11 (2004). Revenue
rulings likewise are not binding on the courts. N. Ind. Pub. Serv. Co. v.
Commissioner, 105 T.C. 341, 350 (1995), aff’d, 115 F.3d 506 (7th Cir. 1997).
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proposed placing certain assets in a liquidating trust for the benefit of holders of
allowed claims. See id. The CCA provides that “[g]enerally, liquidating trusts are
taxed as grantor trusts with the creditors treated as the grantors and deemed
owners” under the theory that “the debtor transferred its assets to the creditors in
exchange for relief from its indebtedness to them, and that the creditors then
transferred those assets to the trust for purposes of liquidation.” Id.In our case, however, apparently neither Sterling nor CFC was aware of the
creation of the liquidating trusts before receiving the notifications sent by Mr.
Winter in the late afternoon of December 31, 2009, much less agreed to relieve
IDG or Gales Creek Terrace LLC from its respective indebtedness in exchange for
the assets that were transferred to the liquidating trusts. The predicate underlying
the CCA is simply not present, and this administrative guidance offers no insight
here.
Mr. Sage next turns to a string of revenue rulings. See Rev. Rul. 72-137,
1972-1 C.B. 101; see also Rev. Rul. 80-150, 1980-1 C.B. 316; Rev. Rul. 75-379,
1975-2 C.B. 505; Rev. Rul. 63-245, 1963-2 C.B. 144. In each, a corporation had
enacted a plan of complete liquidation that required distribution of all assets
within 12 months. With the consent of the shareholders in each instance, certain
assets not readily disposed of were placed in liquidating trusts for the
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shareholders’ benefit. The Commissioner concluded that placing such assets in
liquidating trusts complied with the requirement of divestment within 12 months
because the shareholders had essentially received the assets that were transferred
to the trusts.
Again, Mr. Sage’s unilateral transactions in which he placed properties in
trusts without any involvement from the beneficiaries does not resemble the
factual situations addressed in the revenue rulings. And we see nothing in them to
suggest that liquidating trusts qua liquidating trusts should be treated differently
under the grantor trust rules absent the involvement of the beneficiaries.20
2. Interest Received from the Grantor of a Liquidating Trust
Mr. Sage further argues that Sterling and CFC were grantors of the trusts
under section 1.671-2(e)(3), Income Tax Regs., which provides that the term
“grantor” includes any person “who acquires an interest in a trust from a grantor of
the trust if the interest acquired is an interest in * * * liquidating trusts described
20
Mr. Sage argues in a footnote that the lenders ratified the liquidating trust
transactions by not filing suit or taking other action to overturn or void them. In
support Mr. Sage relies upon an Oregon case addressing ratification of an agent’s
actions by a principal. Lemley v. Lemley, 188 P.3d 468, 473-475 (Or. Ct. App.
2008). Lemley plainly has no applicability here. In any event, the record before
us shows that both Sterling (in the January 2010 email from a Sterling employee)
and CFC (in its February 2010 demand letter) notified Mr. Sage that they did not
view the liquidating trust transactions as having any practical effect.
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in § 301.7701-4(d) of this chapter”. According to Mr. Sage, Sterling and CFC
“acquire[d]” interests by virtue of being named beneficiaries and, therefore, are
grantors.
We are unconvinced. The only example in the regulations illustrating the
operation of section 1.671-2(e)(3), Income Tax Regs., refers to the acquisition of a
pre-existing grantor’s interest after the formation of the trust: “A makes an
investment in a fixed investment trust, T, that is classified as a trust under §
301.7701-4(c)(1) of this chapter. A is a grantor of T. B subsequently acquires A’s
entire interest in T. Under paragraph (e)(3) of this section, B is a grantor of T with
respect to such interest.” Sec. 1.671-2(e)(6), Example (2), Income Tax Regs.
Moreover, if Mr. Sage is right on this point, every beneficiary of a liquidating trust
is automatically a grantor, with the tax repercussions that follow. If the
regulations intended such a sea change, we believe that they would say so
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directly.21 See Time Ins. Co. v. Commissioner, 86 T.C. 298, 320 (1986);
Bituminous Cas. Corp. v. Commissioner, 57 T.C. 58, 83 (1971).
D. Conclusion
As explained above, the grantor trust provisions dictate that IDG and Gales
Creek Terrace LLC be treated as the owners of the respective trusts at issue
beyond the close of 2009. IDG’s transfers of the properties to the trusts thus did
not produce losses realized in 2009. We will sustain the IRS’ deficiency
determinations for Mr. Sage’s 2006 and 2012 taxable years (as modified by
respondent’s concession).
III. Accuracy-Related Penalty
Mr. Sage has conceded that if we resolved the loss issue in respondent’s
favor, he would be liable for a $1,540 accuracy-related penalty under section 6662
21
We further observe that, even assuming that Mr. Sage’s reading of
sec. 1.671-2(e)(3), Income Tax Regs., were correct (i.e., Sterling and CFC were
grantors), the result in this case would not change. The grantor trust regime
contemplates the possibility for multiple grantors to be treated as the owners of a
single trust. See, e.g., sec. 1.671-4(b)(3), Income Tax Regs. (prescribing certain
reporting obligations for trustees “[i]n the case of a trust all of which is treated as
owned by two or more grantors or other persons”). Mr. Sage fails to show that the
banks’ status as grantors has any effect on our analysis as to IDG and Gales Creek
Terrace LLC.
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for his 2012 taxable year. We accordingly sustain the penalty determination for
that year.22
IV. Conclusion
In sum, we hold that Mr. Sage is liable for income tax deficiencies for his
2006 and 2012 taxable years. We further conclude that he is liable for an
accuracy-related penalty under section 6662 for his 2012 taxable year.
To reflect the foregoing,
Decision will be entered under
Rule 155.
22
The Commissioner normally bears the burden of production with respect
to an individual taxpayer’s liability for, inter alia, any penalty. See sec. 7491(c);
Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). Consideration of that
burden of production is unnecessary where, as here, the taxpayer concedes the
penalty. See Frost v. Commissioner, 154 T.C. ___, ___ (slip op. at 20) (Jan. 7,
2020).