By: Edward Brown, Esq.
In a recent Tax Court ruling (see
T.C. Memo. 2019-4 UNITED STATES TAX COURT JOHN F. CAMPBELL, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 5644-12L. Filed February 4, 2019), Mr. Campbell owed federal income taxes relating to his 2001 tax year. Without knowing that an audit of his 2001 tax return would ultimately occur resulting in a tax deficiency in excess of a million dollars, on April 26, 2004, Campbell created (and funded with $5 million) a foreign trust in which he was a beneficiary. Such trusts are viewed as offshore asset protection trusts.
The trustee of the trust created by Campbell (the “Trust”) was a corporate trustee in the Caribbean Islands (Nevis). Campbell designated a third party to serve as the “Protector” of the Trust. A Protector has the authority to change who serves as the trustee. The Protector can consider any requests from Campbell to change the trustee. In fact, in response to Campbell’s request, the current trustee was selected to replace the prior trustee. Campbell felt that the replaced trustee had been overbilling the Trust.
On May 10, 2004, the IRS notified Campbell that his 2001 Form 1040 was being submitted for examination.
Campbell disagreed with the eventual tax assessment by the Internal Revenue Service and the proposed levy of his assets. He requested an offer-in-compromise (OIC) with the hopes of establishing that a reduced tax payment of only $12,603 should be payable by him in light of the doubtfulness of the collectability of his tax obligations.
Using the guidelines provided by the Internal Revenue Manual (IRM) and national and local standards for living expenses, the IRS calculated that Campbell’s reasonable collection potential (RCP) was $1,499,698, partly based on the fact that Campbell placed $5 million into the Nevis trust. The IRS’s calculation included the “net realizable equity” in the Trust of $1,493,912. The IRS Appeals Officer later determined the RCP was instead $19,500,000 based on the view that Campbell had dissipated assets and placed assets beyond the reach of the government.
The Tax Court took into consideration that 6 years ran between the creation and funding of the Trust and the date of the tax assessment. Also, there was a ten-year period between (i) the creating and funding of the Trust and (ii) Campbell submitting his OIC.
The Tax Court also stated that even if Campbell had been aware of his potential tax liability when he created the Trust, his net worth after making the contribution to the Trust exceeded any potential tax liability arising from the examination of his 2001 Federal tax return.
The IRS however argued that the Trust assets should be factored into the determination of how much Campbell had to pay in taxes since Campbell (and hence the IRS) has access to the Trust assets. In support of that position, the IRS argued that the Trust was simply Campbell’s nominee. The Tax Court noted however that Connecticut (Campbell’s state of residence when he petitioned the Tax Court) has not developed a body of law with regard to any nominee theory. The IRS, however, indicated that the Supreme Court of Connecticut would adopt Federal principles of a nominee theory. Although that argument was made, the IRS did not present any evidence that Connecticut courts have ever applied or adopted any such nominee theory. The Tax Court therefore concluded that the Court was not in a position to say that the judicial branch of Connecticut would adopt such a theory. The Court did note however that the IRS for some reason did not address the alter ego theory in its second supplemental notice of determination. Alter ego theories usually look into whether the entity that owns the assets has not been respected as being separate and apart from the debtor (e.g., commingled funds, the entity being controlled by the debtor, etc.).
The Tax Court took the position that since the IRS could not show that Campbell had any property right in the Trust under state law, the Court concludes that the determination by the IRS that the Trust was Campbell’s nominee was arbitrary, capricious, and without sound basis in fact or law. Accordingly, the Tax Court ruled that the IRS abused its discretion when the IRS Appeals officer considered the Nevis trust assets to be a factor in determining whether Campbell’s $12,603 offer to resolve his tax liability was acceptable. The Tax Court stated that the Trust assets were
not considered to be available to Campbell for purposes of determining the RCP.
As a closing comment, it is interesting to note that the IRS argued that since Campbell appointed the Trust Protector, and because the Trust indirectly invested in some of Campbell’s business ventures, Campbell should be viewed as maintaining sufficient control over the Trust and thus having access to the Trust’s assets. The Tax Court nevertheless responded with the view that the trustee, in its sole discretion, directed Trust assets to be so invested and that Campbell could not and did not control this decision, even though Campbell proposed some of the Trust investments.