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Temp. Reg. 15A.453-1(b)(3)(i). Similarly, a taxpayer engaging in a section 1031 exchange is treated as receiving "boot" (and is required to recognize any realized gain) to the extent that the liabilities assumed by the exchange counterparty exceed the liabilities assumed (plus the cash paid) by the taxpayer in the exchange. Reg. 1.1031(b)-1(a) and -.
Liability assumptions can also result in gain recognition or other tax consequences when property is transferred to or from a corporate entity or partnership. For instance, when a taxpayer transfers property to a controlled corporation in exchange for stock, the taxpayer is required to recognize gain under section 357- if the corporation "assumes" liabilities of the taxpayer in excess of the tax basis of the transferred property.
Similarly, a liability "assumed" by a partnership in connection with a property contribution by a partner can, in certain circumstances, be included in the sale price of property deemed sold to the partnership (See Reg. 1.707-5), or, in other contexts, treated as a deemed distribution to, or contribution by, the partner that affects the partner's tax basis in its partnership interest or, in some circumstances, produces gain (See section 752(a) and (b)).
In these fact patterns and in others, the issue often arises as to whether the taxpayer can avoid the adverse tax consequences of a debt assumption by an agreement to remain liable for the debt. That is where Seggerman Farms waxes superior to Lessinger. In Seggerman Farms, the recent appellate court decision sheds a lot of light on how the Seventh Circuit Court of Appeals views the issue of corporate liability for corporations that are essentially the same entities as their owners. Seggerman Farms, Inc. v. Commissioner, 90 AFTR 2d 2002-6981 (7th Cir. 2002).
The 1999 Act to a large degree dismisses the specific issue raised in Seggerman Farms for future transactions as mentioned above. Under section 357(d), a simple guarantee will often just not be enough to prevent a debt assumption from occurring, especially where the facts establish that the transferee agrees to assume the liability and is expected to be the primary source of payment.
However, Seggerman Farms continues to have implications outside of areas covered by section 357- and the 1999 Act (e.g., partnership transfers). It confirms that in the Seventh Circuit, the retention of liability for a debt by a transferor of property is not by itself enough to prevent an assumption of the debt from occurring for tax purposes, unless the transferor retains primary, rather than secondary, liability for repayment of the debt - in other words, the exact opposite, to a certain degree, of the result in Lessinger.
In addition, the Seventh Circuit's analysis of Peracchi and Lessinger suggests that in the Seventh Circuit, a taxpayer can avoid a debt assumption by issuing an offsetting promissory note, which was not addressed in section 357(d).
In other words, Seggerman Farms set such a powerful precedent that it effectively modified the interpretations going forward of Lessinger as well.
The basic impact of Seggerman Farms also outdoes Lessinger in scope as well. Usually, a transfer of assets to a newly formed corporation where the debt involved exceeds the basis triggers gain to the extent the indebtedness exceeds the basis.
The basis of stock received by the transferors is the basis of property transferred, less "boot" received and plus gain recognized, if any exists. If a corporation, however, assumes a liability of the transferor or takes property subject to a liability -- for instance, a mortgage -- the amount of the liability is treated as "money received" and concretely lowers the basis of stock received. As a result, since negative basis figures are not possible, the excess of indebtedness over basis is gain.
In calculating the amount of gain recognized when several assets are transferred to a corporation, each asset is considered separately in exchange for a portion of each category of consideration received, and this is another contribution of Seggerman Farms.
As mentioned earlier, the taxpayer in Seggerman Farms argued that the excess of liabilities over basis (which totaled $510,690) should not be subject to income tax by the IRS because the transferors remained personally liable on the debt obligations.
However, the Tax Court established that it has consistently ruled that debt in excess of basis was subject to tax on the gain involved even if the transferors remained personally liable on the debt obligations. The taxpayers relied on Lessinger v. Commissioner (where the difference between the basis of property and debt was recorded as a loan receivable from the taxpayer to the corporation) and Peracchi v. Commissioner (the difference between the basis of assets and the liabilities transferred was recorded as a personal note from the taxpayers to the corporation).
The IRS responsed by taking the position that the structure of the transactions in Lessinger and Peracchi was different from the way the transfer was handled in Seggerman Farms, Inc. In that the taxpayers in Seggerman did not contribute loan receivables or personal notes to the corporation to cover the difference between the transferred liabilities and the basis of the transferred property. The Tax Court agreed with the distinction urged by the IRS.
The court also cited a Seventh Circuit Court of Appeals case, Testor v. Commissioner, which denied relief to a taxpayer with a gain on incorporation where indebtedness exceeded the basis.
With the number of cases it cites and the overarching tax implications for taxpayers, corporations and CPAs, Seggerman Farms is the more correct decision and holds the greater impact.
Seggerman Farms v. CIR, 90 AFTR 2d 2002-6981 (7th Cir. 2002).
Lessinger v. CIR, 872 F2d 519 (2d Cir. 1989).
Testor v. Commissioner, 327 F.2d 788 (7th Cir. 1989).
Rosen v. Comm'r, 62 T.C. 11 (1974).
Peracchi v. Commissioner, 143 F.3d 487 (9th Cir. 1998).
Indiana Business Review. (Fall 2004). Calculating Income Tax Liability. http://www.ibrc.indiana.edu/ibr/2004/fall04/fall04_sidebar.html.
California Ministry of Agriculture, Food and Rural Affairs. (August, 2001). The Farm Corporations. http://www.gov.on.ca/OMAFRA/english/busdev/facts/01-057.htm
New Mexico State University. (2005). Taxes, Liability Key Issues for Farm Businesses. http://cahe.nmsu.edu/news/1996/021296_taxliability.html.
American Bar Association. (1999). The Farm Credit System. http://www.aba.com/aba/pdf/farmcreditsystem.pdf.[continue]
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