Most attorneys (ourselves included) normally counsel their clients to keep good records and document as much as they can. In most cases, that practice provides the best assistance in case something goes wrong. But, every now and then, a case shows that sometimes handshakes really can be better than documentation. The most recent example saved the taxpayer about $500,000.
This case dealt with the taxation of intangible assets. A father built up a large business distributing ice cream to supermarkets and independent outlets. The foundation of the operation was the personal contacts which the father made and nurtured. In time, he made his son his partner. The father never entered into any kind of written relationship with the corporation of which he was shareholder and officer.
A major segment of the business came from a well-known brand of premium ice cream which had been unable to obtain sufficient shelf space in supermarkets for itself. The father obtained the space and was thanked with a long term relationship created by a handshake and never reduced to writing. Both parties prospered.
In time, father and son had some policy disagreements and decided to split up the business. The ice cream manufacturer had been sold and the new owner wanted to consolidate its distribution while at the same time prohibiting the father from using his contacts to assist competitors. This decision presented both parties with an opportunity. The father could sever his professional relationship with his son and the ice cream company could terminate its relationship with the father's business on terms acceptable to everyone. To accomplish this, the main business formed a subsidiary which became wholly owned by the father. The father made a deal with the ice cream company, reported the income on his personal return (as he was required to do), and everyone thought the matter concluded.
Except the IRS. The government contended that because the subsidiary had never conducted an operating business, the distribution to the subsidiary of the intangible rights which the father sold was a taxable transfer and assessed a deficiency of almost $500,000. The Tax Court, on appeal, found that many of the assets which the subsidiary sold to the ice cream manufacturer were intangible and, because the father did not have a written non-competition agreement or employment agreement with his corporation, the intangible assets remained the property of the father and could not be attributed to (or subject to tax from) the corporation.