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by CPLS PA
T. Scott Tufts, Tax Law

I DIDN’T GET THE STOCK?–Ex-Wife Still Treated as Shareholder of Administratively Dissolved S Corp

04 / 09 / 2019
Bonilla v. United States, 2109 U.S. Dist. LEXIS 47853 (D.Conn. March 22, 2019)
Family Law/Business Practitioners/CPAs Must Remain on Alert!!!!
Issue:  Can a wife in a divorce be taxed on a company awarded to her if the corporation is administratively dissolved years prior to the divorce and the stock certificates have yet to be transferred into her name?
Yes, says a Federal court.  Under the concept of “beneficial ownership” a federal court says.  It doesn’t matter that the S corporation was administratively dissolved years prior or had stopped filing tax returns.  It had received K-1s from a partnership, and it was addressed to the husband’s company, but used the wife’s address after their divorce.  The lawyers sent the K-1s for this S corporation, which was the husband’s 100% owned company.  The fact that the stock certificates had not been transferred over to the wife as a result of the divorce decree ordering him to do so did not matter!  Beneficial ownership had vested with the wife, under the divorce decree.
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Here are the facts of the case. 
Bobby Bonilla is famous.  Bobby Bonilla played major league baseball.  Bobby Bonilla was married at one time to Migdalia Bonilla.  They were divorced on May 22, 2009 by way of a decision in Connecticut Superior Court.  In a 2009 divorce decree, the court ordered that ownership of certain companies Bobby Bonilla owned had to be divided up equally within 30 days. 
One of the companies owned by Bobby Bonilla was one called Bobby Bo Investments, Inc., which as of February, 1994, he was 100% owner, the sole shareholder, officer, director, and President.  However, the Florida Division of Corporations administratively dissolved Bobby Bo Investments, Inc. on August 25, 1995.  It was never reinstated.
Nearly a year later, Ms. Bonilla filed a Motion for Contempt, claiming that Bobby Bonilla had not yet done this.  At a hearing in May, 2010, Mr. Bonilla’s counsel represented to the court that Bobby Bonilla was willing to give his ex-wife all of the companies other than Bobbie Bo Investments, Inc. (“BBI”), a Florida corporation.  Mr. Bonilla’s counsel filed a moton to amend the 2009 decree as part of an effort to keep BBI.
On December 14, 2010, the court held a hearing at which time it was discussed that no transfers of stock certificates for BBI had occurred.  At the hearing, the parties agreed that Ms. Bonilla “will actually be the owner and “will have ownership of” BBI.  The burden to effectuate a transfer of the interests was placed on Ms. Bonilla’s counsel.
Despite being administratively dissolved, BBI in fact held Bobby Bonilla’s interest in a LLC company known as Performance Imaging.  For many years, BBI contributed money to Performance Imaging, but did so from Bobby Bonilla’s personal income.  Bobby Bonilla first invested money into Perfomance Imaging in 1996, contributing $100,000.  Perfomance Imaging had other “investor members” and K-1s were issued each year to them.  Perfomance Imaging never made income distributions to its members, nor has it covered members’ tax costs.
The K-1s for Performance Imaging as issued to BBI liste it as having a 69.51 percent interest in profits, loss, and capital. 
BBI did not even file S corporation tax returns in the years 2009, 2010, or 2011.
On September 16, 2010, Ms. Bonilla received the BBI Performance Imaging K-1 via e-mail.
On September 30, 2011, Ms. Bonilla’s attorney sent Performance Imaging a copy of the 2009 divorce decree and a transcript of the Decembrer 2010 hearing, and her address.  The address listed for BBI on these Performance Imaging K-1s for the years 2010 through 2016 are Ms. Bonilla’s residence.  Each year, Ms. Bonilla forwarded these K-1s to her accountant.
For the 2010 tax year, the BBI Performance Imaging K-1s reported business income of $908,871.
For the 2011 tax year, the BBI Performance Imaging K-1 reported busienss income of $61,112.
The IRS conducted a TEFRA audit of Performance Imaging.  (A TEFRA audit was mandated because Performance Imaging was a LLC, with a S corporation as one of its members).  As a result of this TEFRA audit, the IRS determined that Performance Imaging’s ordinary business income was understated, and should have been $1,122,706, but Ms. Bonilla did not report ANY portion of BBI’s portion on her 2010 and 2011 tax returns.  
The IRS came in, and automatically increased Ms. Bonilla’s ordinary income by $780,393, and $55,117, equal to 69.51 percent of Performance Imaging’s corrected 2010 and 2011 ordinary business income.  These adjustments resulted in assessments of tax by the IRS against Ms. Bonilla of $235,783 and $19,291 for the 2010 and 2011 tax years.  When fees and penalties are added, Ms. Bonilla owed to the IRS $323,164, $21,871.74 for the 2010 and 2011 tax years.
Ms. Bonilla eventually pays these tax liabilieis on April 11, 2016, and then files a claim for refund, which the IRS administratively then denies on October 3, 2016.  While the Government eventually conceded that $372,023 of the $780,393 increase to Ms. Bonilla’s income for the 2010 tax year was incorrect, and directed the IRS to abate the  tax, penalties, and fees levied against Ms. Bonilla to this extent, they refused to abate the amounts any further.  
This led to the Federal refund suit. 
One of the first arguments raised by the Government was that the “variance doctrine” precludes the court from reviewing Ms. Bonilla’s claim BBI could not have acquired an interest in Performance Imaging because BBI had been administrative dissolved and that any agreement reached at the December 2010 hearing resulted in an unenforceable agreement “to agree.”
The court looked at Ms. Bonilla’s administrative claim.  In that claim, she specifically argued that against the IRS’ determination that she was the owner of BBI (and not contesting issues related to the TEFRA audit of Performance Imaging).   However, the administrative claim made no mention of BBI’s ability to obtain an ownership interest in other companies–and specifically, made no mention of the argument that administrative dissolution itself barred BBI from holding an interest in Performance Imaging.  Therefore, the Federal Court ruled that it was without jurisdiction to rule on the merits of that particular argument.
Ms. Bonilla’s administrative claim did not expressly make the argument that the divorce proceedings court decree was an unenforceable “agreement to agree.”  However, the Federal court noted that her stated view in her claim was that the divorce proceedings were insufficient to transfer ownership of BBI from Bobby Bonilla to her.  In other words, whether or not an effective transfer of ownership took place was the focus of her administrative claim and Ms. Bonilla took issue with the IRS over its finding that she was the owner pursuant to the divorce proceedings.  Thus, the court found that this was not a substantial variance from the arguments put forth in the administrative claim.  Thus, the Federal court found that it did have jurisdiction to address this particular argument.
The Federal Court held that there was no genuine issue of material fact as to whether the parties intended to enter into an agreement to resolve all outstanding divorce issues at the December 2010 hearing, including in particular, ownership of BBI.  With a court approved stipulation and order, this was sufficient and deemed akin to a judgment obtained through litigation. 
Ms. Bonilla then argued that she should have been awarded summary judgment because the IRS “improperly determined her ownership interest in BBI without first issuing a statutory notice of deficiency.”  This she could not do becasue the question before the court is limited to whether a genuine issue of material fact exists as to whether Ms. Bonilla overpaid her tax.
The court then turned to whether Ms. Bonilla was entitled to summary judgment on the arguments that BBI, as an administratively dissolved corporation, could not transfer its shares to her, that Ms. Bonilla was never issued any BBI shares under Florida law or the UCC, and Ms. Bonilla was not a beneficial owner of BBI in 2011 or 2011. 
The Government contends that summary judgment should be awarded in its favor because irrespective of whether Ms. Bonilla received legal title to BBI shares, she was a beneficial owner of BBI in 2010 and 2011.  
The Federal Court agrees with the Government.  First, the Federal court finds that pursuant to the divorce decree, ownership could be transferred, and that the Government is right–for federal tax purposes, stock ownership is determined by beneficial ownership, not legal title.  Second, that there is no genuine dispute of material fact that Ms. Bonilla was a beneficial owners of BBI during the tax years in question.  The Federal Court looked at whether it was required to apply the factors set forth by the Tax Court in Dunne v. IRS, T.C. Memo 2008-63.  The Federal Court then established that it is not bound by Dunne, that it was state law that was to determine whether a taxpayer has a beneficial ownership interest.  Since the divorce decree issued in May 2009 ordered that BBI was to be divided equally by the parties within 30 days from the date of the decree, it was after expiration of these 30 days that Ms. Bonilla had an enforceable interest in a 50% interest in BBI.   Then, in December, 2010, when the parties entered into an enforceable agreement, later incorporated into court order, that resolved all outstanding issues in the divorce, such that beneficial interest in all of BBI rested with Ms. Bonilla as of December 14, 2010.  
As an aside, the Federal court points out that Florida courts have held that one may be a beneficial owner of stock, notwithstanding the lack of legal title to the same.  Smallwood v. Moretti, 128 So.2d 628, 629 (Fla. Dist. Ct. App. 1961); Phillips v. Zimring, 284 So.2d 233, 235 (Fla. Dist. Ct. App. 1973); Acoustic Innovations, Inc. v. Schafer, 976 So.2d 1139, 1145 (Fla. Dist. Ct. App. 2008).
By their ruling, the Federal court thus held that the beneficial owner of shares in an S corporation is liable for the taxes owed on her pro rata share of the corporation’s income, regardless of whether distributions are made.  See 26 C.F.R. Section 1.1366-1(a).  Here, three is no genuine issue of material fact that the Connecticut divorce vested beneficial ownership of BBI in Ms. Bonilla, as to half of the company, at least 30 days following the 2009 Divorce Decree and, as to all of the company following the December 2010 hearing.  Thus, Ms. Bonilla was responsible for the taxes owed on her pro rata share of BBI’s income in the 2010 and 2011 tax years.” 

If you have any questions or need assistance with K-1 or 1099 issues, T. Scott Tufts is able to address these and can be reached , please contact Mr. T. Scott Tufts Senior Tax Counsel at CPLS, P.A., 407-647-7887.

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by CPLS PA
T. Scott Tufts, Tax Law

IS YOUR OPERATING AGREEMENT “BBA COMPLIANT”?

IS YOUR OPERATING AGREEMENT “BBA COMPLIANT”?

What does “BBA Compliant” mean?

For anyone interacting with LLCs, or other entities treated under the Federal Tax law as a partnership (i.e., more than one partner, member, owner), they will be surprised to learn that the concept of a “tax matters partner” (TMP) has come to an end under the 2015 Bipartisan Budget Act, effective January 1, 2018 (“BBA”).  CPAs and tax return preparers can see from the new IRS Forms 1065, 1065X, and Forms 8082 that the term “BBA” is upon us.  But what does the BBA now do?

The BBA is focused on how the IRS will audit LLC and other partnership entities with many members (over a 100) or those with two or more members or partners not otherwise electing to be taxed as a C or S corporation having a certain tiered structure, where one of the members/partners is another partnership or LLC, a revocable living trust, a disregarded entity, or nominee.

When a day comes that the IRS wishes to pursue any “understatement” arising in any LLC, the IRS will ask first–is this entity subject to the BBA?  The IRS will look at the representations on the Form 1065, and inquire further. If it is, the IRS will now know that they will no longer have to pursue or chase down indirect partners using the arcane TEFRA audit rules.  More importantly, a TMP does not exist under the BBA.  Instead, there must be a “partnership representative” designated and it is the LLC entity itself that may be charged with a proposed assessment of tax liability due and owing to the Department of the Treasury.

As practitioners look at the new IRS Form 1065 (2018), question 25 prompts them to then consider how best to analyze whether their particular entity can “opt out” of these new audit rules, using Schedule B-2 (Form 1065).  If they cannot, or there is risk that a “non-eligible” partner/member can become a “partner” (member), then they will have to proceed with the designation of a Partnership Representative (and if that representative is an entity, an individual who will speak for that Partnership Representative entity).  Who is best able to serve in this role?  What fiduciary duties might that person have?  Does a Statement of Authority need to be filed with the Secretary of State in Florida to announce the role?  What rights to indemnification or reimbursement or advancement are to be afforded to this Partnership Representative when serving in this role?  What are the procedures to be employed when reviewing K-1s and other financial information when preparing returns?

This change in the manner in which partnership entities are to be audited at the Federal level mandates that a “partnership representative” be appointed who need not be a partner/owner/member.  The audits may focus on prior years of a partnership entity in which there were different partners (reviewed year partners) when compared to the current year.  How the partnership entity addresses these new rules and the elections that may be made, mandate careful drafting.

Is your operating agreement ready for this change in the manner in which LLC and other partnership entities are going to be audited by the IRS?  What due diligence is being employed to know if your agreement is BBA Compliant?  Is it critical to prevent transfers by individuals to disregarded entities like a revocable living trust, or require written consent, if that transfer will then mandate compliance with the BBA and designation of a “Partnership Representative”?  These and so many other questions now arise under the BBA.  It is imperative that practitioners act now to make sure that their operating agreement is BBA Compliant.

If you have any questions about the BBA, or whether your operating agreement is BBA Compliant, please contact T. Scott Tufts at CPLS, P.A., 407-647-7887.

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