Monday, March 17, 2003
Precision Pine & Timber, Inc. had paid for covenants not to compete for specific periods of years from three other potential timber companies in Arizona. PP&T began amortizing these covenants at based on their duration in years. Afterwards, the Mexican Spotted Owl was placed on the endangered species list, and two years later, in the tax year at issue, the District Court issued an injunction that effectively ended new timber harvesting in Arizona, in an area encompassing the entire geographical reach of the covenants. PP&T deducted as a loss the entire unamortized portions of the covenants, based on the theory that they were now worthless, because the covenantees were prevented from competing because of the owl. IRS disallowed the loss.
In a fact-based analysis, Tax Court found that the covenants were indeed worthless. In a rare display of Shakespearian wit, Tax Court stated, �In short, the covenants were not worth a hoot.� IRS had relied on ABCO Oil Corp. v. Commissioner, where the taxpayer had entered into fixed-year covenants not to compete with three individuals, began amortization, then claimed a loss when two of the individuals died. Tax Court distinguished ABCO Oil because the test for worthlessness requires, among other things, that the taxpayer make a subjective determination that the covenants were now worthless, yet the taxpayers in ABCO Oil had continued to make payments on the noncompetition agreements years after the covenantees deaths. This is good, legally relevant reason for distinguishing ABCO Oil, but it seems somewhat disingenuous. Tax Court notes that they stated in ABCO Oil that the death of the convenantees did not make the covenants worthless, rather the covenantees� �deaths extended forever the duration of noncompetition.� Tax Court in this case fails to explain why this logic does not apply to PP&T. The best explanation is that ABCO Oil�s logic does apply, but Tax Court found a good excuse to distinguish it because it is utterly stupid. How much would you pay a dead guy not to do something you do not want done? Sounds worthless to me.
PP&T also wanted to change the allocation of a contact to one of the covenants not to compete from $200,000 to $0, but Tax Court said they had no reason to change the allocation since PP&T had not filed a new Form 8594.
UPDATE: Stuart Levine writes:
"In your discussion of Precision Pine & Timber, you should have noted that the transactions involved were undertaken before the effective date of Section 197 and that Section 197(f)(1)(B) would, in most cases, obviate the taxpayer's argument and change result."
I would say that Stuart is most likely completely right about the law, and half right about what I should have said. My goal here in Decnavda�s Dialectic to provide summaries of Tax Court opinions and to critique their reasoning and presentation, relying solely on the text of the opinion itself. I really do not have time to go beyond the opinion and determine how the case would have been decided under the new section 197. That said, Tax Court did actually mention in the opinion that section 197 had been updated and implied, without explaining, that it would affect the outcome of the case. I should have mentioned their mentioning of this change as a red flag to send readers interested from a planning perspective back to the Code. In the future, I will try to include this information when it appears that it would have a substantive effect on the decision. If I miss any more, or if you just want to go outside the text of the opinion for me, feel free to email me your comments as Stuart did. Thanks, Stuart!