Practitioners are debating the implications of the recent Tax Court decision in Canal Corporation and Subsidiary, et. al., v. Commisioner of Internal Revenue, 135 T.C. No. 9 (8-5-10), which involved an LLC contribution of a corporate subsidiary's balance sheet to a new LLC in exchange for a small residual interest, and the LLC's subsequent distribution of financing proceeds that were distributed to the contributing member under an arrangement whereby the member had agreed to indemnify the other member and the LLC for the distribution indebtedness. The Tax Court found the member had insufficient assets to support the indemnity obligation and the indemnity covenant could not be relied upon to allocate the LLC debt to the contributing member, and that the disguised sale rules under IRC Section 707(a)(2)(B) applied. The Tax Court also imposed a substantial understatement penalty, holding that no reliance could be placed upon the tax opinion issued by the taxpayer's advisor due to bias resulting from the opinion writer having participated in the structuring of the transaction and therefore lacking sufficient objectivity to provide a basis of reliance. See the link below for a copy of the case.
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