A recent Tax Court case has shed new light on an old succession planning technique using the “Oldco/Newco” structure. This article examines Bross Trucking, Inc. v. Commissioner (T.C. Memo 2014-107) and its implications in succession planning for contractors.

1. Succession Planning: A Fresh Look at an Old Technique
A recent Tax Court case has shed new light on an old succession planning technique using the “Oldco/Newco” structure. This article examines Bross Trucking, Inc. v. Commissioner (T.C. Memo 2014-107) and its implications in succession planning for contractors.
Background
The Oldco/Newco structure is a typical succession planning technique used by contractors with no significant inventories or property plant and equipment that wish to pass their companies on to their children (or key employees, or a combination of both). This structure can help successors take over the business and also provide the retired parent significant payments.
In its simplest version, a new entity (Newco) is formed by the children and/or key employees and takes on all new work. Oldco’s existing contracts are either completed by Oldco, assigned to Newco (if allowable), or completed by Newco under a service agreement with Oldco. Oldco sells or leases its equipment, as well as rents space and provides working capital to Newco for fair and adequate consideration. Oldco also guarantees lines of credit and the bonding line for which it receives guarantee fees.
Typically, the employees of Oldco go to work for Newco and the owner of Oldco becomes a consultant to Newco for a number of years at a set annual fee. The operating agreement of Newco limits distributions to the owners of Newco to pay taxes, and compensation to employees of Newco is specified by employment contracts.
The goal is to build up Newco to be a viable, standalone business. Once Newco reaches a certain targeted net worth and no longer needs assistance, it will establish its own credit and bonding lines and Oldco can be liquidated.
With this planning technique, the new ownership group focuses on the future of the business, not its past. If done correctly, the future business of Oldco gets transitioned to Newco without significant income or gift tax consequences.
Other important aspects of this structure are:
1) There are no taxable sales of stock or membership interests by the parent. The parent owner of Oldco
can defer the taxation of his or her interest in Oldco and can share in the earnings of Newco through a
consulting agreement.
2) There are no transfers subject to gift tax, assuming
that the consideration for what is transferred from Oldco to Newco meets the arm’s length standard
as fair and reasonable under the circumstances.
3) The new owners do not need to find sources of
financing to fund the company and only need
minimal capital to start Newco since they do not
need to purchase any stock or incur any debt.
4) Finally, the parent also achieves an “estate freeze”
for the ownership interest in Oldco, since he or she
will only receive the book value of the company
upon liquidation.
Although the future business of Oldco has effectively been “transferred” to Newco without an outright sale, Newco must pay arm’s length consideration to Oldco and/or its owner, as appropriate, for any value transferred to Newco. This may be in the form of interest, fees, purchase price, rent, or other consideration for loans, guarantees, equipment, the use of office facilities, or other value.
Such intangible assets as goodwill, an established revenue stream, a developed customer base, an established workforce, and continuing supplier relationships must also be considered. The transfer of these types of intangible assets without adequate consideration could draw an income tax at the Oldco level when transferred to the retiring owner. In addition, a gift tax could also be incurred by the retiring owner who may be treated as having transferred these intangibles to Newco.
The Tax Court recently addressed these issues in its decision in Bross Trucking, Inc. v. Commissioner (T.C. Memo 2014-107).
BY MICHAEL DESIATO & CORD D. ARMSTRONG
CFMA Building Profits November/December 2014
Copyright © 2014 by the Construction Financial
Management Association.
All rights reserved. This
article first appeared in
CFMA Building Profits.
Reprinted with permission.

2. tax & LEGISLATION
The Bross Trucking Case
In this case, the IRS contended that Bross Trucking, Inc. distributed intangible assets to its owner, Chester Bross, who then made a gift of those intangibles to his three sons, who in turn organized a new trucking company, LWK Trucking Co, Inc. The alleged value of the intangible assets would have generated an income tax at both the corporate and individual levels, and required that Bross file a gift tax return and pay gift tax for the year 2004.
Case Summary
Bross organized Bross Construction in 1972 to engage in various road construction projects. His customers were the highway departments of Missouri, Illinois, and Arkansas. As his business grew, he organized several other companies to provide services and equipment to the construction projects.
Bross was extremely knowledgeable about the construction industry and contributed to nearly all facets of the business. He personally developed relationships with the necessary entities to work in the road construction industry. Furthermore, Bross was responsible for fostering and maintaining relationships under the Bross family business umbrella to ensure that projects were successfully completed.
In 1982, he established Bross Trucking, Inc. (Bross Trucking), which specialized in hauling construction-related materials and equipment for road construction projects. Bross Trucking leased its trucking equipment from another wholly owned Bross entity, CB Equipment. In addition to Bross Construction, Bross Trucking, and CB Equipment, Bross’ family members owned CB Asphalt and Mark Twain Redi-Mix, all of which were customers of Bross Trucking. No formal written service agreements were ever created between these entities and Bross Trucking.
While owning 100% of Bross Trucking, Bross did not have an employment contract with Bross Trucking and he never signed a noncompete agreement that would prohibit him from competing against Bross Trucking if he left the company. In fact, no employees of Bross Trucking ever signed noncompete agreements. None of his three sons ever worked for Bross Trucking; his wife and two of his sons owned Mark Twain Redi-Mix.
Beginning in the late 1990s, Bross Trucking was the subject of heightened regulatory scrutiny from the DOT and the Missouri Division of Motor Carriers and Railroad Safety to the point where there was a risk that Bross Trucking could be shut down.
As word spread and customers grew concerned, Bross, on advice of his attorney, decided to cease Bross Trucking operations rather than risk a potentially adverse cease and desist order.
In July 2003, Bross’ three sons formed a different type of trucking company that provided more services than Bross Trucking, called LWK Trucking. Bross was not an owner and not involved in the management of LWK Trucking. LWK Trucking independently satisfied all of the regulatory requirements to be in business by obtaining the appropriate insurance and licenses.
Bross Trucking remained a viable entity, complete with insurance and its licenses as well, while using its assets to pay the legal expenses of the pending cases against it. LWK Trucking hired about 50% of the employees that had worked for Bross Trucking and executed a new master lease agreement with CB Equipment after Bross Trucking’s vehicle leases terminated.
IRS Position
When a corporation distributes appreciated assets to a shareholder, the corporation must recognize gain as if the property were sold to the shareholder at its fair market value. Gain is recognized to the extent that the property’s fair market value exceeds the corporation’s adjusted basis in the assets distributed. The same rule also applies to S corporations, except that the tax burden is passed through to the shareholder.
The IRS contended that Bross Trucking distributed the following intangible assets to Bross:
1) goodwill,
2) established revenue stream,
3) developed customer base,
4) transparency of continuing operations between
the entities,
5) established workforce including independent
contractors, and
6) continuing supplier relationships.
In its notice of deficiency, however, the IRS wrapped all of these separate intangibles into a single package labeled “goodwill.”
The IRS determined that there was first a distribution of intangible assets by Bross Trucking to Bross that resulted in a corporate tax deficiency of almost $900,000, in addition to an accuracy related penalty of close to $200,000.
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3. The IRS also assessed gift taxes and penalties of approximately $1.7 million against Bross on the subsequent alleged gift of those distributed intangibles to his three sons, which, the IRS claimed, the sons transferred to their new trucking company.
Tax Court Analysis
The Tax Court first addressed whether or not Bross Trucking distributed appreciated intangible assets to its sole shareholder (Bross). The Court stated that a company can only distribute assets it owns and not intangible assets owned by its shareholders, citing Martin Ice Cream Co. v. Commissioner, 110 T.C. 189, 209 (1998). The Court went on to indicate that there are two regimes of goodwill:
1) Personal goodwill developed and owned by
shareholders, and
2) Corporate goodwill owned by the company. In this
case the Court determined that Bross Trucking’s
goodwill was owned by Bross personally, and therefore the corporation owned nothing that could be
transferred to him.
The Court said that other than “workforce in place,” nearly all of the other components of “goodwill” listed previously stemmed from Bross’ personal relationships. Bross Trucking’s established revenue stream, its developed customer base, and the transparency of the continuing operations were all spawned from Bross’ work in the construction industry.
In other words, Bross Trucking’s customers chose to patronize the company solely because of the relationships that Bross personally forged. His experience and relationships with other businesses were valuable assets, but assets that he owned personally.
According to the Court, while Bross Trucking might have had corporate goodwill at some point, it would have been fully impaired at the time of the alleged transfer because of the negative attention resulting from state investigations and impending suspensions. Furthermore, the lack of corporate goodwill was demonstrated by LWK Trucking removing the Bross Trucking name from any leased equipment to avoid confusion between the two companies.
In addition, there was no evidence that LWK Trucking benefited from any supplier relationships from Bross Trucking and no indication that LWK Trucking used any relationship that Bross personally forged. The Bross sons were in a similarly close capacity to Bross Trucking’s customers to develop relationships apart from their father.
The Court said cultivating and profiting from independently created relationships are not, however, the same as receiving transferred goodwill. The facts showed that LWK Trucking employees created their own goodwill and there was no transfer of Bross’ goodwill to either his sons or LWK Trucking.
The Court also determined that Bross did not transfer any of his personal goodwill to Bross Trucking through an employment contract or noncompete agreement. He was free to use his personal goodwill in direct competition with Bross Trucking if he stopped working for the company.
The Court reasoned that the only attribute of goodwill that Bross Trucking may have corporately owned and transferred to Bross was a workforce in place. The IRS argued that there was a transfer since “most” of the Bross Trucking employees became LWK Trucking employees. However, the Court was not convinced that most of a workforce in place was transferred since only 50% of the employees were prior employees of Bross Trucking. Instead, it appeared to the Court the LWK Trucking assembled a workforce independent of Bross Trucking, which was demonstrated by the new key employees and new services offered by LWK Trucking.
The Court also determined that Bross Trucking did not transfer a developed customer base or revenue stream to LWK Trucking since preexisting Bross Trucking customers had a choice of trucking options and chose LWK Trucking. This was not an organized transfer between Bross Trucking and LWK Trucking, but rather one that was done in light of impending suspensions against Bross Trucking and a business choice made at the customer ‘el.
Finally, Bross Trucking did not distribute any cash assets and retained all the necessary licenses and insurance to continue business. Bross remained associated with Bross Trucking and was not involved in operating or owning LWK Trucking.
He was free to compete against LWK Trucking and use every cultivated relationship in order to do so. The fact that Bross Trucking could have resumed its hauling business supports the view that it retained any corporate intangibles. Accordingly, there was no transfer of intangible assets because Bross Trucking’s customers chose to use a different company and Bross Trucking remained a going concern.
CFMA Building Profits November/December 2014

4. Takeaways from this Case
Property
The Tax Court cites and follows the key cases backing the “property” theory of personal goodwill, finding that Bross had personal goodwill separate from the goodwill of Bross Trucking and that he did not transfer that goodwill to his company. This may demonstrate a trend away from other court decisions that have held that goodwill is not property that can be transferred but rather “future earning potential” of the person who creates it, which cannot be transferred.
Intangible Assets
The Tax Court also discusses and identifies the other intangible assets that make up “goodwill” (e.g., established revenue steam, customer relationships, supplier relationships, and workforce in place), and that these are separate assets that can be sold or transferred and accordingly have tax consequences.
Valuation
In the typical Oldco/Newco structuring technique, one must carefully evaluate if “goodwill” or its related subparts are being “transferred” by either Oldco or its owners to Newco. If so, one must be sure that a proper valuation is placed on those transfers and those making the transfers are adequately compensated.
The facts in this case were taxpayer friendly, particularly where LWK Trucking was formed for business reasons (potential suspension of Bross Trucking’s business) and not for succession planning. In addition, only 50% of the employees of LWK Trucking were previously Bross Trucking employees and Bross Trucking remained in existence as a going concern able to compete with LWK Trucking.
If the formation of LWK Trucking was done as part of a succession plan with Bross Trucking being phased out as a going concern and with most its employees being transferred to LWK Trucking, then this case may have concluded differently.
Conclusion
Even though the facts surrounding most succession plans are quite unlike the Bross Trucking case, it serves as a reminder of the types of tangible and intangible assets that could be subject to scrutiny by the IRS if transferred without adequate consideration using the Oldco/Newco technique. Any succession plan using this type of structure should be thoroughly reviewed with your tax advisor prior to enactment. n
MICHAEL DeSIATO, CPA, CExP, CFP®, is Managing Director in the Tax Department of CBIZ MHM, LLC and shareholder in Mayer Hoffman McCann, PC in Miami, FL. He specializes in proactive tax planning and compliance for large and middle market companies primarily in the construction, real estate, distribution, travel, and broadcast industries.
He has been practicing public accounting for more than 35 years and advises clients on tax issues, asset and estate tax planning, tax minimization techniques, personal financial, and exit planning matters.
A member of CFMA’s South Florida Chapter, Michael holds a BS in Accounting and MS in Taxation from Florida International University.
Phone: 305-503-4224
E-Mail: mdesiato@cbiz.com
Website: www.cbiz.com
CORD D. ARMSTRONG, CPA, CCIFP, is Managing Director in the Tax Department of CBIZ MHM, LLC and shareholder in Mayer Hoffman McCann, PC in Phoenix, AZ, where he is involved in all aspects of federal and state taxation, including compliance, planning, and research.
Cord has more than 20 years of experience in public accounting and is responsible for the supervision of staff in various tax compliance and research matters for individuals, businesses, trusts, and estates. He also specializes in estate and gift tax matters and has represented corporate and individual clients before the IRS and other state and local tax authorities.
A member of CFMA’s Valley of the Sun Chapter and previous author for CFMA Building Profits, Cord also belongs to the AICPA and Arizona Society of CPAs.
Phone: 602-264-6835
E-Mail: carmstrong@cbiz.com
Website: www.cbiz.com
tax & LEGISLATION
November/December 2014 CFMA Building Profits