Two cases illustrate IRS challenges after a transfer of property to a new corporation:

Uly O. Thompson organized Moline Properties Inc. at the suggestion of creditors. They agreed to lend more money on his property only if he transferred it to a new corporation and pledged the stock to them.

The corporation didn't keep books or a bank account. It held title to no assets except the land and $1,000 for renting it. But when the property was sold, Thompson reported the gain.

Not so fast, said the IRS. Moline Properties owes taxes.

This would result in double taxation: first the corporation, for the gain on the sale, then Thompson because he received the money, like a dividend.

The judge ruled for the IRS. He said Thompson chose the corporate form and cannot now ignore its existence by saying it was merely a "dummy."

In another case, the owner didn't go the dummy route but instead treated his corporation as valid and as his agent. Jesse C. Bollinger Jr. wanted to borrow money to build an apartment in Lexington, Ky. The loan company wanted 8 percent interest, but under Kentucky law, charging this rate to noncorporate borrowers is usurious. So he formed Creekside Inc. which borrowed the money. The corporation transferred the money to Bollinger, who hired a construction supervisor. Upon completion of construction, he managed the apartment, kept the income and paid the expenses. Lenders regarded him as the apartment owner and the corporation his agent.

The apartment lost money four out of the next five years. Bollinger reported the losses and the one-year profit on his personal returns.

These were corporate losses, said the IRS. It added that the court should follow the Moline case by ruling the corporation is valid. And it should rule that the agency relationship is invalid.

The court gave the losses to Bollinger. It said the corporation was valid, and it was his agent for these reasons:

1. When the company got the property, a written agreement designated the corporation an agent.
   
2. The corporation functioned like an agent.
3. The corporation held itself out as an agent in dealing with third parties.
   

Comments: To get added assurance with an agency plan, ask your tax CPA to consider making an S election, if the corporation is eligible. This election usually avoids the double tax; the owner, not the corporation, pays taxes on company income.

In any case, don't transfer assets to keep them away from the IRS - it won't work. And, it may not protect assets from other creditors either.(more at Other Planning)

The Moral: The IRS is no dummy when it comes to sham corporations.

Released 4-29-02