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Hawk v. Commissioner of Internal Revenue

United States Court of Appeals, Sixth Circuit

May 15, 2019

Billy F. Hawk, Jr., GST Non-Exempt Marital Trust, Trustee, Transferee, Nancy Sue Hawk and Regions Bank, Co-Trustees; Estate of Billy F. Hawk, Junior, Trustee, Transferee, Nancy Sue Hawk and Regions Bank, Co-Executors; Billy F. Hawk, Jr., GST Exempt Marital Trust, Trustee, Transferee, Nancy Sue Hawk and Regions Bank, Co-Trustees; Nancy Sue Hawk, Transferee, Petitioners-Appellants,
v.
Commissioner of Internal Revenue, Respondent-Appellee.

          Argued: April 30, 2019

          Appeal from the United States Tax Court; Nos. 30024-09; 30025-09; 30026-09; 30515-09-Joseph R. Goeke, Judge.

         ARGUED:

          J. Eric Butler, LEWIS, THOMASON, KING, KRIEG & WALDROP, P.C., Knoxville, Tennessee, for Appellants.

          Arthur T. Catterall, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee.

         ON BRIEF:

          J. Eric Butler, Katherine Sanford Goodner, LEWIS, THOMASON, KING, KRIEG & WALDROP, P.C., Knoxville, Tennessee, Ashley Hodges Morgan, LEWIS, THOMASON, KING, KRIEG & WALDROP, P.C., Memphis, Tennessee, David S. Garbett, Brian P. Yates, GARBETT, ALLEN & ROZA, P.A., Miami, Florida, John P. Konvalinka, GRANT, KONVALINKA & HARRISON, P.C., Chattanooga, Tennessee, for Appellants.

          Arthur T. Catterall, Gilbert S. Rothenberg, Richard Caldarone, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee.

          Before: GUY, SUTTON, and NALBANDIAN, Circuit Judges.

          OPINION

          SUTTON, Circuit Judge.

         After Billy Hawk died in 2000, his wife Nancy Sue decided to sell the family bowling business, Holiday Bowl. With the help of lawyers and accountants, she made a deal with MidCoast, a company that claimed an interest in acquiring companies with corporate tax liabilities that it could set off against its net-operating losses. Holiday Bowl first sold its assets-bowling alleys-to Bowl New England, receiving $4.2 million in cash and generating about $1 million in federal taxes. After that, Nancy Sue and Billy's estate sold Holiday Bowl to MidCoast for about $3.4 million, in essence exchanging one pile of cash for another minus the tax debt MidCoast agreed to pay. But MidCoast never paid the taxes. The United States filed this transferee-liability action against Nancy Sue Hawk and Billy Hawk's estate to recover Holiday Bowl's unpaid taxes. The Tax Court ruled for the government, concluding that the Hawks were transferees of a delinquent taxpayer under federal law and permitting the government to recover the unpaid taxes from the Hawks under Tennessee law. We affirm.

         I.

         When shareholders sell a privately held corporation, they have a range of options. One is an asset sale, in which the corporation sells its assets (e.g., the bowling alleys), pays a tax on the gain, and distributes what's left to the shareholders. In this setting, the Commissioner taxes the corporation upon the sale of the assets and taxes the shareholders when they receive their distributions.

         Another option is a stock sale, in which the shareholders sell their stock to a third party. Because the corporation never sells its assets, the transaction doesn't trigger corporate tax, and the original shareholders pay only their individual income taxes. If the new owners dispose of the corporate assets down the road, however, the corporation will incur taxes then. Buyers in a stock sale often pay less to account for future taxes they must pay.

         After Billy Hawk's death in 2000, Nancy Sue owned almost a fifth of the company's stock and her husband's estate owned the remainder. Billy and Nancy Sue's two sons operated the two bowling alleys awhile. But that didn't work. By 2002, she realized she needed to sell Holiday Bowl. She chose an asset sale to Bowl New England. The sale left Holiday Bowl with $4.2 million in cash and left the company owing about $1 million in federal income taxes and about $200, 000 in state taxes. Holiday Bowl also owned some real property, a family horse farm that Nancy Sue wanted to keep, valued at $777, 000.

         Trying to lower the corporate taxes triggered by the transaction, the Hawks' broker approached their attorney with information about a company called MidCoast that had "tremendous tax-loss carry-forwards." J.A. 3 at 797. If MidCoast bought Holiday Bowl, the broker advertised, Holiday Bowl would not need to pay corporate taxes on the asset sale. As a result, MidCoast promised to pay the Hawks more than Holiday Bowl's actual value-what would have been its cash on hand minus outstanding taxes. Nancy Sue Hawk and the estate stood to keep an extra $200, 000 to $300, 000 by structuring the transaction in this way. MidCoast purported to offer Holiday Bowl a way to realize the best attributes of an asset sale (the higher sale price of the assets) and a stock sale (no corporate-level tax). In closing his recommendation, the broker, warily but not warily enough, said: "[I]f it seems too good to be true, it probably is. But maybe this is the exception." Id. at 798.

         The Hawks proceeded to enjoy what looked like a free lunch. Under the purchase agreement, the Hawks sold Holiday Bowl some of their shares in exchange for the company's remaining property, the horse farm. That left Holiday Bowl with nothing but cash. MidCoast paid $3.4 million plus expenses for Holiday Bowl's $4.2 million. To finance the transaction, MidCoast claimed it would borrow money from a company called Sequoia Capital. According to MidCoast, Holiday Bowl would then enter the debt-collection business, rapidly generating new losses that would offset Holiday Bowl's existing taxes.

         After the sale, MidCoast transferred Holiday Bowl to Sequoia in exchange for the cancellation of Sequoia's loan and about $320, 000 in cash. No one ever paid Holiday Bowl's outstanding taxes, and the one-time bowling company dissolved in 2006.

         The Internal Revenue Service investigated MidCoast, uncovering the Holiday Bowl sale and about sixty similar transactions. That did not end well for MidCoast, Sequoia, and a law firm, as a grand jury indicted several individuals associated with each of them. One defendant pleaded guilty. Others fled the country. The government launched a civil collection proceeding against the Hawks in pursuit of Holiday Bowl's unpaid taxes. The Tax Court concluded that Sequoia's loan to MidCoast was a sham and that Holiday Bowl had ...


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