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The basic idea is really strange. Apparently Michael owns 77% of the business and Thomas 23%. What's the difference between Thomas buying his brother's 77% and the business itself buying that 77%? If I own 23% of a business which otherwise owns itself then I am surely the 100% owner. Share buybacks are just share deflation.
I think it's a good ruling based on a tortured tax workaround. The business did own that life insurance policy, after all.
The difference is that the cash spent on the buybacks reduces the value of the company. To use the example from the case, suppose I hold an 80% share in a company whose only asset is 10 million in cash; that 80%share is worth 8 million. Redeeming the other 20% costs the company 2 million, so now I hold a 100% share of a company worth 8 million. The redemption hasn't affected the value of my shares. If, on the other hand, I purchased the 20% interest from the other investors, my shares, the company would still have 10 million in the bank, and my 100% share would be worth 10 million.
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Before his death: Company is worth 3.86 million dollars.
Literally the one second that you're calculating taxes: Company is worth 6.86 million dollars (or if they had planned properly and did the algebra, 16.78 million)
After his death: Company is worth 3.86 million dollars.
They could have set it up so that some external entity A) held the insurance policy, and B) had the obligation to destroy the shares once obtained. If they had, the second entity would obviously be worth zero dollars (because its assets match its liabilities perfectly) and the normal business would be worth 3.86M throughout.
Or if they had structured it as a survivor's benefit, so that Thomas got the money and the obligation to buy Michael out.
Or, or, or...
The intent was clear. Just let people make agreements without hopping through hoops.
There is no one second hypothetical here as there's no legal assumption that any of the events happened simultaneously — he dies, some time thereafter the insurance is paid out, and some time after that the company completes the redemption. In real life we're probably talking several months. At the time of Michael's death the company was worth 6.86 million, and it continued to be worth as much after his death.
And while the intent may have been clear, the means used had the effect of nearly doubling the company's value. It's easy to talk about intent, but eventually this devolves into "I intended to minimize my tax burden", and you end up having to give the benefit of the doubt to people who take actions wherein reducing the tax burden is clearly contrary to public policy. Practically any tax avoidance scheme, no matter how hard brained, becomes effective. The fact that convoluted schemes are often used is unfortunate, but it's the nature of the business.
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Can you just destroy shares you own? I would think the process would be something more like share "renunciation" which would have tax implications for the company whose shares you own.
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Wouldn't you need to include the net present value of the insurance plan, which would be nonzero before the death, and zero afterwards? Although that may not be the letter of accounting law in terms of marking asset values.
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