Tax News
Sollberger v. Commissioner: The Tax Court Continues to Slam Monetization Strategies
April 21, 2011
In a recent decision the Tax Court rejected yet another monetization attempt in the case of Kurt Sollberger v. Commissioner, T.C. Memo. 2011-78 (April 4, 2011).  This seems to shape a Tax Court trend considering that the court held against the taxpayer in the other two monetization cases that were decided last year, Calloway, 135 T.C. No. 3 (July 8, 2010) and Anschutz, 135 T.C. No. 5 (July 22, 2010). I previously reasoned on this blog that the negative result in the Anschutz case seemed to stem from poor execution than anything else.  So what went wrong in the Sollberger case? In this case the taxpayer was an owner of a manufacturing company.  The company adopted an ESOP plan and the taxpayer sold some of its shares to the plan.  The taxpayer then decided that it will defer the gain on the sale pursuant to Section 1042 by acquiring qualified replacement property (QRP). With the money the taxpayer purchased some floating rate notes (FRNs) sold by Bank of America. So far so good. The FRNs were QRPs and the taxpayer was able to defer the gain on the sale to the ESOP.

Later however, the taxpayer entered into a loan agreement with a third party whereby it “borrowed” 90% of the value of the FRNs and secured this loan by pledging the floating notes. The loan was nonrecourse which meant that the taxpayer would not be entitled to the return of the FRNs if he did not repay at the end of the loan term. The third party could keep the FRNs if the taxpayer did not repay the loan but could not sue for any unpaid balance on the loan.  Furthermore the loan provided for net interest only, i.e the third party collected the interest on the FRNs and offset it against any interest due on the loan. Lastly, and most importantly, the documents provided that the “lender” could "assign, transfer, pledge, repledge, hypothecate, rehypothecate, lend, encumber short sell and/or sale" the FRNs during the term of the loan without notifying the taxpayer.  The readers out there that have followed variable prepaid forwards and the IRS guidance regarding those monetization strategies know that the right to sell or hypotheticate the collateral is usually problematic for achieving loan treatment.

So what did the court rule here? The Tax Court did not delve into too much analysis.  There was apparently no bona-fide debtor-creditor relationship and the benefits and burdens of ownership passed to the third party “lender.” The Tax Court also noted that these transactions are not that different from the decisions in Calloway and another recent case called Shao.  This was sufficient for the court to rule against the taxpayer.  Could the result have been different? Sure, as in the other recent cases, the documents and the transaction in general should have been structured with greater attention to the benefits and burdens of ownership analysis, particularly the sale and hypothetication of collateral element.  On a broader note, this case and the previous cases should come as a warning that the IRS is taking monetization strategies to court.  Funds should be extra cautious when structuring monetization transactions.
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Tags: monetization, Sollberger v. Commissioner, variable prepaid forward, VPF