In a recent Tax Court decision, the court reviewed the activities of the Huffman family as it pertained to corporate dealings involving the family aviation business (Infinity Aerospace Inc. which the court refers to by its previous name of “Dukes”), making findings with regards to reasonable cause, valuation of personal goodwill, correct reporting of capital gains and dividends, and the necessity of gift tax returns on a part of 2 generations of couples.

The court highlighted two primary issues in these consolidated cases: (1) whether Patricia and the Estate of Lloyd Huffman made a taxable gift when Chet Huffman exercised his rights in the right-to-purchase (RTP) Agreements in 2007, buying DRM’s and the Trust’s shares in Dukes for $5 million; and (2) whether Cindy and the Estate of Chet Huffman, as well as Dukes, properly reported the gain from the sale proceeds of the TransDigm acquisition in 2009 related to Chet’s personal goodwill and CCC&B’s intellectual property assets.

Dukes was incorporated in California in 1958 to manufacture and supply engineering components for the aerospace industry. Lloyd and Patricia Huffman were original shareholders and formed the Huffman Family Trust, which held Lloyd’s shares in Dukes. Lloyd stepped down as president of Dukes in 1987 whereupon his eldest son Chet Huffman was made CEO and issued a 5,000 (0.7%) of outstanding shares.

Various purchase agreements were made, by Lloyd and Chet, two of which were with Dukes affiliates owned by the Trust and another owned by Patricia. Chet greatly expanded the business with his leadership, with many more affiliates and licensees attached to Dukes by the late 80s, and later led to a proposed acquisition by Hanwha Corp., a Korean company.

Valuations were created to proceed with the acquisition and MOU between Dukes and Hanwha, and ultimately, Hanwha decided not to pursue the acquisition. On the basis of the Ninth Circuit’s analysis in Estate of Mitchell, the court agreed with petitioners that the IRS’s initial determination as to the personal goodwill was arbitrary. The court held that Chet’s goodwill was retained until the TransDigm acquisition and the government bore the burden of proof on the issue of valuing Chet’s personal goodwill as it related to the TransDigm acquisition of Dukes in 2009.

The government’s view was the shares were worth approximately $31.3 million and so the differential value between the purchase price and the true fair market value should be deemed a gift. Petitioners of course opposed, arguing the RTP Agreements were valid business arrangements and therefore determinative as to the value of the Dukes shares. However, the court disregarded the agreements, referring to the interrelatedness of the parties, and reviewed them with respect to section 2703 with a heightened level of scrutiny. While the agreements purported not to be compensatory, Chet did accept a reduced salary during his years as Dukes’s CEO. Given his significant contributions to the company, the court found the reduced salary to be consideration for the RTP agreements and therefore not any testamentary gift, holding Section 2703(b)(2) satisfied.

As for the second issue, the family’s CPA of many years, Tracy Ross-Stearn, stepped down abruptly, leaving the Huffmans suddenly needing new tax professionals for their accountancy and reporting. This disrupted the Huffmans’ ability to timely submit accurate returns. Ms. Ross-Stearn and TransDigm also demonstrated extreme reluctance and delay to provide necessary financial statements. After Ms. Ross-Stearn quit, the Huffmans, as well as Dukes, hired 2 accountants to help them submit all the individuals’ and Dukes-affiliated entities’ tax returns. These accountants were also relied on to best determine how to report the sale proceeds from TransDigm’s asset purchase of Dukes with what data they had. The court held Chet and Cindy Huffman and also Dukes relied in good faith on the successor accountants to report what they could accurately, and found reasonable cause with respect to the TransDigm proceeds and underpayment, finding them not liable for Section 6662(a) penalties.

By the same token, Cindy and the Estate of Chet Huffman argued reasonable cause for the Section 6651(a) penalties on untimely filings. However, the court relied upon Boyle to confirm that the taxpayer is ultimately responsible for timely filings and sustained the Section 6651(a)(1) and (2) additions to tax for Cindy and the Estate of Chet Huffman and Dukes. The court conversely found reasonable cause did exist for Patricia and the Estate of Lloyd Huffman with any gift tax, as Ms. Ross-Stearn failed to advise them of a potential gift tax liability affecting their failure to file a return for that year, as distinguished from a timeliness argument.

The court’s decision reinforces the importance of thoughtful planning of transactions involving related parties, as well as a comprehensive and careful defense, due to drawing increased scrutiny from the IRS and the Tax Court.

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