Estate of Kluener v. Commissioner

Robert Kluener was the sole shareholder and chief executive officer of the American Power Equipment Company (APECO). APECO experienced significant losses, entitling it to a $5.3 million federal-tax net operating loss (NOL). APECO also had significant debt, for which Kluener was personally responsible, and Kluener and his wife, Charlotte (plaintiff), had more than $12 million in debt. However, Kluener also owned thoroughbred horses, which he decided to sell. In consultation with his tax advisors, in August 1989, Kluener transferred the horses to APECO, which could sell them without incurring tax liability due to its NOL. Kluener caused APECO to form a new division (APECO Equine) to own the horses, and he actively concealed APECO’s horse ownership from most of APECO’s management. In late 1989, APECO received a windfall payment from a customer, delaying its need for cash. But, in July 1990, needing money, Kluener caused APECO to sell the horses for $2.5 million and transfer the proceeds to him. APECO reported the sale on its tax return but did not pay tax on the sale due to the NOL; the Klueners neither reported the sale on their return nor paid tax on it. The Internal Revenue Service (IRS) determined that Kluener, rather than APECO, sold the horses and thus assessed a deficiency and imposed an accuracy-related penalty against the Klueners pursuant to Internal Revenue Code (code) § 6662. Kluener’s estate (plaintiff) and Charlotte sued the United States (defendant) in the United States Tax Court arguing that (1) APECO should be treated as having sold the horses because the transfer to APECO was partially motivated by the legitimate business purpose of capitalizing APECO and (2) the penalty was unwarranted because there was substantial factual authority for treating APECO as the seller. The Tax Court ruled in favor of the United States without considering the adequacy of the proffered factual authority. The estate and Charlotte appealed.