Recapture of LIFO reserve.

• Author: Schuth, Michael R.
• Position: Last-in first-out inventory accounting - S corporations

The Eleventh Circuit has reversed the Tax Court in Cog, gin Automotive Corp., 115 TC 349 (2000). It decided not to require a holding company that changed from a C to an S corporation to recapture its pro-rata share of partnership LIFO reserves, because the company had no LIFO inventory itself. In so holding, the Court of Appeals also struck down the Tax Court's arbitrary invocation of the "aggregate" theory of subchapter K, relying instead on the statute's plain meaning.

Coggin was a C holding company that filed a consolidated return with five subsidiaries. Each of the subsidiaries operated as an automobile retailer and used the dollar-value LIFO method for their inventories. Coggin merely owned stock in its subsidiaries, without operating any business. More importantly, Coggin did not own inventory and never made a LIFO election.

In 1993, Coggin's majority shareholder elected S status for the corporation in a restructuring plan consummated for non-tax-motivated business masons. In the plan, Coggin shareholders created six new S corporations to act as general partners hi six new limited partnerships (LPs). Each S corporation contributed cash in exchange for a 1% general partnership interest. Immediately thereafter, each of Coggin's subsidiaries contributed its assets and liabilities (including its inventory) to the partnerships in exchange for an LP interest. The subsidiaries were then liquidated into Coggin, and Coggin became the LPs' limited partner. Following the liquidations, Coggin elected S status.

Tax Court

The Tax Court acknowledged the valid business purpose of the restructuring; it assisted Coggin's majority shareholder's succession planning and allowed the businesses to provide flexible ownership incentives to their key employees. The court looked to subchapter K to determine whether the tax consequences related to the LIFO inventory reserves in the newly created partnerships should be determined under the "entity" or "aggregate" theory. Under the entity theory, the partnerships are considered entities separate from their owners. Under the aggregate theory, each partner is viewed as owning a direct interest in each partnership asset and is directly taxed on a share of partnership income.

The Tax Court held that the legislative history and Sec. 1363(d) mandate the application of the aggregate approach. Further, the application of an aggregate approach better served Congress' intent to prevent corporations from avoiding double...