Anschutz Co. v. Commissioner illustrates the difficulty of determining whether a built-in gain must be recognized when taxpayers use new types of customized derivatives to monetize an appreciated asset. In this case, the Tax Court and the Tenth Circuit applied “benefits and burdens” analyses and held that variable prepaid forward sales of stock, which used the same collateral stock to satisfy concurrent share-lending agreements, caused recognition of gain. This Note argues that although the Tax Court and Tenth Circuit arrived at the correct result, the courts’ failure to focus on the Taxpayers’ intent to subvert the Code resulted in unnecessarily broad and deficient opinions.
The Service claimed over $130 million in deficiencies for Philip F. Anschutz and the Anschutz Company (collectively, Taxpayers). The deficiencies depended on the treatment of the built-in gain resulting from a series of stock transactions entered into by the Anschutz Corporation (TAC), a qualified subchapter S corporation. In July 2010, the Tax Court found three reasons why this “nontraditional loan” produced recognizable gain under section 1001 of the Code. First, the Tax Court found that the forward sales and lending agreements were “clearly related and interdependent” because they were presented together by the counterparty, Donaldson, Lufkin, & Jenrette Securities Corporation (DLJ), and were the subject of the same negotiations. Second, the court found that the Taxpayers transferred the benefits and burdens of the stock at issue, thereby disposing of the stock for U.S. tax purposes. Lastly, the court found that the section 1058 safe harbor did not apply because the structure violated section 1058(b)(3) as the forward sale limited the lender’s risk of loss with regard to the underlying shares. The Tenth Circuit subsequently affirmed the Tax Court decision by applying a similar benefits and burdens test.
This Note suggests that the courts’ sweeping conclusion that the Anschutz transaction required the recognition of gain is overly broad. Contrary to the courts’ decisions, a variable prepaid forward sale coupled with a share loan, on its face, is not a taxable disposition of the shares. A look at the full background and surrounding facts of the Anschutz transaction, however, shows that the Taxpayers designed the transaction to dispose of the stock while avoiding the subchapter S built-in gains tax. This Note proposes that the courts could have found taxable recognition in the Anschutz transaction by reading section 1374 as embodying a minimum holding period requirement, narrowing the decision, and leaving intact the law surrounding variable prepaid forward sales with share loans.
Accordingly, Part II describes the relevant law surrounding the built-in gains tax for subchapter S corporations and securities lending agreements. Part III illustrates the transaction at issue in Anschutz and details how the courts determined that the transactions resulted in recognition of the gain on the shares. Part IV deconstructs the transaction and presents alternative reasoning for a finding of recognition of gain.