United States

Taxpayer's claim that its documents were 'mutual mistake' fails

Taxpayer held to documented form of stock sale

TAX ALERT  | 

The taxpayer in Makric Enterprises, Inc. v. Commissioner contracted to sell the stock of its subsidiary Alpha Circuits, Inc. for $16.5 million in 2008. The tax result for taxpayer’s shareholders would be better if they had sold the parent corporation’s stock. The taxpayer and its shareholders decided that the shareholders would report the stock sale on their tax returns and the taxpayer would not report it.    

The IRS assessed a tax deficiency and tax penalties together totaling over $3.4 million. The courts have upheld the assessments, demonstrating the importance of structuring transactions to achieve desired tax results.

Stock sale transaction

A manufacturer, Alpha Circuits, Inc. (Alpha) was 100 percent owned by a holding company, Makric Enterprises, Inc. (Makric). Makric was owned by three individuals. In 2007 they pursued a sale of Alpha, engaging the assistance of an investment bank. In 2008, they found their buyer – TS3 Technology, Inc. (TS3).

Initial discussions were for the sale of Alpha by Makric. Makric’s shareholders would realize a better tax result if they sold their Makric stock to TS3 instead. TS3 was amenable to structuring its purchase of Alpha in a manner that provided a better tax result for the selling shareholders. However, the parties did not fully consider how to achieve this tax benefit. Makric and its shareholders did not involve their tax advisors in structuring the sale.

In the end, the sale documents specified that Makric’s sale of Alpha stock to TS3. Makric’s CFO told Makric’s tax return preparer (inaccurately) that the sale documents specified the shareholders’ sale of their Makric stock to TS3, rather than Makric’s sale of Alpha stock to TS3. The tax return preparer prepared returns for Makric and its shareholders that reported stock sales by Makric’s shareholders, and no stock sale by Makric.

Taxpayer’s request for contract reformation based on mutual mistake rejected

Makric contested the IRS’ assessment of about $3.4 million of tax and penalties. It asked the Tax Court to reform the sale contract as a contract for the sale of Makric stock. The Tax Court held that the taxpayer’s evidence was not sufficient to support a reformation of the contract, and the Fifth Circuit affirmed the Tax Court’s decision. The tax and penalty assessments were upheld.

Conclusion

The taxpayer here had opportunities to achieve its desired tax result. First, by getting a mergers and acquisitions-knowledgable tax advisor closely involved in their $16.5 million business sale, they could have structured the deal to achieve the right result.

Second, an erroneously-structured deal can sometimes be restructured by application of the rescission doctrine. The IRS’ approval of the rescission doctrine is well-established under the criteria of Rev. Rul. 80-58. It requires quick action, with a rescission accomplished within the same tax year as the original transaction.

Instead of pursuing these routes, however, the taxpayer here just reported the transaction as if it had been structured in the more tax-favorable manner. It tried supporting its position with arguments based on intent and mistake, which were not persuasive.

Taxpayers considering the sale or acquisition of their business should consult with their tax advisors prior to the sale or acquisition.

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