                      115 T.C. No. 28



                UNITED STATES TAX COURT



     COGGIN AUTOMOTIVE CORPORATION, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 1684-99.                     Filed October 18, 2000.


     P was a holding company that held over 80 percent of
the stock of five corporations (collectively, the
subsidiaries) that were engaged in the retail sales of
automobiles and light trucks conducted through six
dealerships. From 1972 or 1973 until and including the
fiscal year ended June 26, 1993, P (as common parent)
filed consolidated corporate income tax returns with its
subsidiaries.    The   subsidiaries   maintained    their
inventories of automobiles and light trucks under the
dollar-value LIFO method of accounting.       P did not
directly own any inventory.

     From Jan. 29, 1970 (the date of incorporation),
until June 27, 1993, P was a C corporation. On or about
Aug. 27, 1993, P elected S corporation status, effective
June 27, 1993.    The election was made pursuant to a
restructuring plan. The restructuring resulted in the
establishment of six new S corporations formed for the
purpose of becoming general partners in six limited
partnerships that would operate the six dealerships.
Each subsidiary contributed the assets and liabilities of
                              - 2 -

     its dealership to a limited partnership in exchange for
     a limited partnership interest. Following the transfer
     of assets to the limited partnerships, the subsidiaries
     were   liquidated.  As   a  result,   P  obtained   the
     subsidiaries’ limited partnership interests.

         R determined that pursuant to sec. 1363(d), I.R.C.,
    P’s conversion to an S corporation triggered the
    inclusion of the affiliated group’s pre-S-election LIFO
    reserves ($5,077,808) into P’s income.       R’s primary
    position was that the restructuring should be disregarded
    because   it   had    no  tax-independent    purpose.   R
    alternatively maintained that under the aggregate
    approach to partnerships, a pro rata share ($4,792,372)
    of the pre-S-election LIFO reserves was attributable to
    P.

         Held:   The restructuring was a genuine multiple-
    party transaction with economic substance, compelled by
    business realities and imbued with tax-independent
    considerations. The restructuring was not shaped solely
    by tax avoidance features.   Consequently, R’s primary
    position that there was no tax-independent business
    purpose for the restructuring is rejected.

         Held, further: The aggregate approach (as opposed
    to the entity approach) to partnerships better serves the
    underlying purpose and scope of sec. 1363(d), I.R.C.
    Accordingly, P is deemed to own a pro rata share of the
    partnerships’ inventories of automobiles and light
    trucks. Consequently, upon its election of S corporation
    status, P was required to include $4,792,372 in its gross
    income as its ratable share of the LIFO recapture amount.



    Sheldon M. Kay and Robert L. LoRay, for petitioner.

     James P. Dawson and Julius Gonzalez, for respondent.



     JACOBS,   Judge:   Respondent    determined   deficiencies   in

petitioner’s Federal income taxes as follows:
                                   - 3 -

          Tax Year Ended                        Deficiency

          June   26,   1993                      $432,619
          Dec.   31,   1993                       432,619
          Dec.   31,   1994                       432,619
          Dec.   31,   1995                       432,619

These deficiencies stem from respondent’s determination requiring

petitioner to recapture its LIFO reserves upon conversion from a C

corporation to an S corporation effective June 27, 1993.

     The issue for decision is whether petitioner is subject to

LIFO recapture pursuant to section 1363(d) as a consequence of a

change in the structure of petitioner and its subsidiaries.            For

the reasons set forth below, we hold that it is.

     All section references are to the Internal Revenue Code as in

effect for 1993.       All dollar amounts are rounded.

                              FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.           The

stipulation of facts and the attached exhibits are incorporated

herein by this reference.

Background

     At the time the petition in this case was filed, Coggin

Automotive   Corp.,    formerly   known    as   Coggin-O’Steen   Investment

Corp., was a Florida corporation with its principal place of

business in Jacksonville, Florida. (Herein, both Coggin Automotive

Corp. and Coggin-O’Steen Investment Corp. are referred to as

petitioner.)
                                      - 4 -

     Petitioner was a holding company.                 Before June 21, 1993,

petitioner     held    over    80    percent    of    the   stock     of     five     C

corporations, namely, Coggin Pontiac, Inc., Coggin Nissan, Inc.,

Coggin-O’Steen Imports, Inc., Coggin-O’Steen Motors, Inc., and

Coggin Imports, Inc. (collectively, the subsidiaries), all of which

were engaged in the retail sales of automobiles and light trucks.

Each subsidiary was incorporated in Florida.

     Six     automobile       dealerships      were   operated       through        the

subsidiaries       (five   through    direct    ownership      and   one     through

ownership of a 50-percent general partnership interest).                     Four of

the dealerships (Coggin Pontiac-GMC, Coggin Honda, Coggin Nissan,

and Coggin Acura) were located in Jacksonville, Florida; one

(Coggin Motor Mall) was located in Fort Pierce, Florida; and one

(Coggin-Andrews Honda) was located in Orlando, Florida.

     From 1972 or 1973 until and including the fiscal year ended

June 26, 1993, petitioner (as the common parent) filed consolidated

Forms    1120,     U.S.    Corporation    Income      Tax   Return,        with     its

subsidiaries       (hereinafter,       the     affiliated      group).1             The

subsidiaries maintained their inventories of automobiles and light

trucks     under    the    dollar-value       LIFO    method    of    accounting.




     1
          Petitioner and its subsidiaries reported their
consolidated income on a 52- to 53-week basis; the fiscal year of
the affiliated group ended in June.
                              - 5 -

Petitioner did not directly own any inventory.      As of June 26,

1993, the accumulated LIFO reserves of the affiliated group were

$5,077,808 (pre-S-election LIFO reserves).

     From January 29, 1970 (the date of incorporation), until June

27, 1993, petitioner was a C corporation.   As of June 27, 1993, the

equity and voting interests in petitioner were held as follows:

     Shareholder         Ownership Interest       Voting Interest

    Luther Coggin              55.0%                    78%
    Harold O’Steen             22.5                     11
    Howard O’Steen             22.5                     11

     Luther Coggin was petitioner’s president and chief executive

officer; Harold and Howard O’Steen (collectively, the O’Steens)

were vice presidents of petitioner.    Mr. Coggin and the O’Steens

were also the three directors of petitioner.   The O’Steens did not

assume an active managerial role in petitioner’s operations.

     On January 2, 1996, the O’Steens sold their stock interests in

petitioner for $30,025,000 pursuant to a redemption and purchase

agreement.

Coggin Pontiac-GMC

     Coggin Pontiac-GMC began its operations in 1968; initially,

its operations were conducted through Coggin Pontiac, Inc.    Before

June 21, 1993, Coggin Pontiac, Inc., owned the assets of its

dealership, including the franchise rights.
                              - 6 -

Coggin Honda

     Coggin Honda began its operations in 1982; initially, its

operations were conducted through Coggin Pontiac, Inc. Before June

21, 1993, Coggin Pontiac, Inc., owned the assets of its dealership,

including the franchise rights.

Coggin Nissan

     Petitioner acquired Coggin Nissan in 1976; initially, its

operations were conducted through Coggin Nissan, Inc.     From its

inception until July 8, 1987, Coggin Nissan, Inc., owned the assets

of its dealership, including the franchise rights.

     On or about July 9, 1987, Michael Andrews, the then-acting

general manager of the dealership, acquired a 5-percent stock

interest in Coggin Nissan, Inc., for $99,442.     Between 1990 and

1997, Todd Seth was the general manager of Coggin Nissan.    On or

about April 1, 1992, Mr. Seth acquired a 5-percent stock interest

in Coggin Nissan, Inc., for $118,581.   The prices paid by Messrs.

Andrews and Seth for their respective interests were determined by

reference to the corporation’s book value (with little or no value

being assigned to the franchise rights), as reflected on the

General Motors Operating Report (GMOR).2




     2
          The General Motors Operating Report is a report
customarily used by General Motors and other automotive dealers
that provides a uniform method of determining certain financial
information for a dealership, including book value for the
dealership.
                                      - 7 -

Coggin Acura

     Coggin Acura began its operations in 1986; initially, its

operations were conducted through Coggin Imports, Inc.                  At all

relevant times,      Jack   Hanania    was    the   general   manager   of   the

dealership.     From its inception until April 30, 1991, Coggin

Imports, Inc. (a subsidiary of petitioner), owned the assets of the

dealership, including the franchise rights.

     On or about May 1, 1991, Mr. Hanania acquired a 20-percent

interest in Coggin Imports, Inc., for $35,000.            The price paid by

Mr. Hanania for his interest was determined by reference to the

corporation’s book value (with little or no value being assigned to

the franchise rights), as reflected on the GMOR.

Coggin Motor Mall

     Petitioner acquired Coggin Motor Mall in 1982; initially its

operations    were   conducted   through      Coggin-O’Steen    Motors,      Inc.

Since 1990, the general manager of the dealership has been Robert

Caracello.     Mr. Andrews was the director of operations for the

dealership from 1993 through 1997.             Since 1982, Coggin-O’Steen

Motors, Inc., has owned the assets of the dealership, including the

franchise rights.

     On or about April 1, 1988, Mr. Caracello acquired 750 shares

of stock in Coggin-O’Steen Motors, Inc.; he subsequently sold 250
                                      - 8 -

of these shares to petitioner for $132,915. Immediately after this

sale, Mr. Caracello held a 5-percent interest in Coggin-O’Steen

Motors, Inc.

Coggin-Andrews Honda

      Coggin-Andrews Honda (f.k.a. Coggin-O’Steen Honda) began its

operations around December 1984.              From 1985 until 1990, Coggin-

O’Steen     Imports,   Inc.     (Imports),     owned    Coggin-Andrews       Honda.

Petitioner owned an 80-percent interest in Imports; the remaining

20 percent was owned by Mr. Andrews.

      In 1989, petitioner agreed to sell the Honda dealership to a

group of investors.        Because of a lack of financing, the deal

collapsed.

      Mr.   Andrews    wanted    to   be   the   sole    owner    of   the   Honda

dealership.       He was upset upon learning that petitioner had agreed

to   sell   the    dealership    without   his   consent.        Thereafter,    he

intensified his efforts to increase his percentage of ownership in

Imports and eventually be the sole owner of the Honda dealership.

      In 1990, Mr. Andrews began negotiations with Mr. Coggin

regarding the acquisition of all the stock of Imports. Ultimately,

it was agreed that Mr. Coggin would immediately sell Mr. Andrews an

additional 30-percent interest in Imports and give him the option

to purchase the entire Honda dealership (including the franchise

rights) after 10 years.
                                    - 9 -

      In order to facilitate Mr. Andrews’ eventual sole ownership of

the dealership, as well as to provide Mr. Andrews immediately with

some degree of control over the dealership’s assets, Mr. Andrews’

attorney, Charles Egerton recommended that the dealership’s assets

be held by a limited partnership.        Mr. Egerton advised Mr. Andrews

that operating the dealership through a limited partnership would

afford Mr. Andrews the following advantages: (1) Limited liability

protection; (2) the ability to make disproportionate distributions;

(3) a single level of taxation; (4) a lower Federal tax rate; (5)

the ability to avoid Florida’s State income tax on his distributive

share of profits; and (6) the ability to exercise greater control

over the potential sale or liquidation of partnership assets.                Mr.

Coggin agreed to have the dealership’s assets held by a limited

partnership.

Coggin-Andrews Partnership

      On December 14, 1990, Imports entered into an agreement with

Andrews Automotive Corp. (Andrews Automotive), an S corporation

solely   owned    by    Mr.   Andrews,      to   form   the    Coggin-Andrews

partnership.      The partnership was created through a series of

related transactions. First, Mr. Andrews redeemed all of his stock

in Imports, receiving in exchange a promissory note in the amount

of   $573,207    (the   note).   (Immediately     prior   thereto,     and   in

contemplation     of    the   redemption,    Imports    made    a   $1,750,000

distribution to petitioner.)        Then, Mr. Andrews contributed both
                                         - 10 -

the note and $107,000 in cash to Andrews Automotive.                             Finally,

Andrews Automotive contributed the note and the $107,000, while

Imports contributed the assets of Coggin Andrews Honda (valued at

approximately $680,000), to the partnership, each receiving in

exchange a 50-percent interest in the partnership.

       Under the terms of the Coggin-Andrews partnership agreement

(the    partnership       agreement),        Imports          was     designated         the

partnership’s managing partner.

The 1993 Restructuring Transactions

       Petitioner’s board of directors determined that because (1)

the general managers wanted to own a direct interest in, and

participate      in,    the     profits     of     a     stand-alone        partnership

dealership, and (2) Mr. Coggin wanted (as part of a succession plan

and to provide liquidity to cover estate taxes) an effective way in

which   the     general   managers       could     buy    him   out,      it     would       be

advantageous      to   change    the     structure       of   petitioner       from      a    C

corporation to an S corporation and to operate the dealerships

through partnerships similar to the Coggin-Andrews partnership.

Consequently, during the latter part of May 1993, the board adopted

a   plan   to    change    petitioner’s           structure         and   that    of     the

subsidiaries      pursuant      to   a   series     of    transactions         (the    1993

restructuring), as outlined in a “talking points paper” prepared by

KPMG Peat Marwick (KPMG).
                                         - 11 -

      Permission from the automobile manufacturers associated with

the particular dealerships had to be obtained before there could be

a    change    in    the   ownership         structure           of    the    dealerships.

Consequently, on or around May 27, 1993, petitioner sent letters to

each of the automobile manufacturers notifying them of the proposed

changes and requested their approval. Each letter stated, in part:

           After serious consideration of the present and
      future tax laws, the shareholders * * * are in the
      process of forming a Florida limited partnership * * *

                           *      *      *        *        *      *       *

           It is our objective to complete the transfer      of
      * * * [the dealership] operation to * * * [the newly
      formed partnership] on or before June 21, 1993.
      Completion of the transfer by that date is critical to us
      for tax reasons.

Each automobile manufacturer approved the ownership change.

      The first step of the 1993 restructuring was the establishment

of   six   new      corporations.            On    May     27,        1993,   articles     of

incorporation were filed for CP-GMC Motor Corp., CH Motor Corp., CN

Motor Corp., CA Motor Corp., CO Motor Corp., and CFP Motor Corp.

(collectively,       the       newly    formed        S   corporations),         and     each

corporation elected S corporation status, effective May 27, 1993.

The corporations were incorporated for the purpose of being general

partners      in    limited      partnerships             that    would       operate    the

dealerships.         Mr.       Coggin    and      the     O’Steens       were    the     sole
                                         - 12 -

shareholders of the newly formed S corporations during all relevant

periods, each holding the same proportion of ownership interests in

the newly formed S corporations as they held in petitioner.

      The second step of the 1993 restructuring was to create

Florida     limited        partnerships.         Contemporaneously     with    the

establishment of the S corporations, petitioner’s subsidiaries, the

S corporations, and several of the dealerships’ general managers

entered into limited partnership arrangements (collectively, the

limited partnerships), as follows:

Name of Partnership           General Partner           Limited Partner

CP-GMC Motors, Ltd.          CP-GMC Motor Corp.       Coggin Pontiac, Inc.
CH Motors, Ltd.              CH Motor Corp.           Coggin Pontiac, Inc.
CN Motors, Ltd.              CN Motor Corp.           Coggin Nissan, Inc.
CA Motors, Ltd.              CA Motor Corp.           Coggin Imports, Inc.
CFP Motors, Ltd.            CFP Motor Corp.          Coggin-O’Steen Motors, Inc.
CO Motors, Ltd.             CO Motor Corp.           Coggin-O’Steen Motors, Inc.

Each general partner held a 1-percent interest in the limited

partnership; each limited partner held a 99-percent interest.

      The   third    step     of   the    1993     restructuring    involved   the

redemption of Messrs. Andrews’, Seth’s, Hanania’s, and Caracello’s

stock interests.          On or about May 31, 1993, Coggin Nissan, Inc.,

redeemed Messrs. Andrews’ and Seth’s stock interests for $143,575

each.   This amount was paid in the form of promissory notes made by

Coggin Nissan, Inc.            Petitioner paid a portion of the taxes

attributable to the gain generated by the redemption.                 On the same

day, Coggin Imports, Inc., redeemed Mr. Hanania’s stock interest

for   $53,849,      and    Coggin-O’Steen         Motors,   Inc.,   redeemed   Mr.
                                 - 13 -

Caracello’s stock interest for $222,133.         Payment for these stock

interests was in the form of a promissory note of the respective

redeeming corporation.      All redemptions were based on the book

values of the dealerships as reflected on the GMOR.

     Next,   on   June   21,   1993,   each    of   the   newly   formed   S

corporations contributed $9,000 in cash to the limited partnership

in which it was to hold an interest.          Simultaneously, (1) Coggin

Pontiac, Inc., contributed the assets and liabilities of its

Pontiac dealership (valued at $5,737,129) to CP-GMC Motors, Ltd.,

(2) Coggin Pontiac, Inc., contributed the assets and liabilities of

its Honda dealership (valued at $3,613,421) to CH Motors, Ltd., (3)

Coggin Nissan, Inc., contributed the assets and liabilities of its

Nissan dealership (valued at $1,600,467) to CN Motors, Ltd., (4)

Coggin Imports, Inc., contributed the assets and liabilities of its

Acura dealership (valued at $85,989) to CA Motors, Ltd., (5)

Coggin-O’Steen Motors, Inc., contributed the assets and liabilities

of its Mercedes Benz/BMW dealership (valued at $3,753,962) to CFP

Motors, Ltd., and (6) Coggin-O’Steen Imports, Inc., contributed its

general partnership interest in the Coggin-Andrews partnership

(valued at $669,504) to CO Motors, Ltd.

     Concurrently, (1) Messrs. Andrews and Seth each contributed

the $143,575 Coggin Nissan, Inc. note to CN Motors, Ltd., in

exchange for a 5-percent (total 10 percent) limited partnership

interest, (2) Mr. Hanania contributed the $53,849 Coggin Imports,
                                   - 14 -

Inc. note to CA Motors, Ltd., in exchange for a 20-percent limited

partnership    interest,    and   (3)   Mr.    Caracello    contributed   the

$222,133 Coggin-O’Steen Motors, Inc. note to CFP Motors, Ltd., in

exchange    for   a   5-percent   limited     partnership    interest.     By

September 30, 1993, the aforementioned notes were canceled.

     Each partnership agreement provided that the general partner,

i.e., one of the newly formed S corporations, would have control

over the operations of the partnership.          Further, each partnership

agreement provided that the general manager/limited partner had to

tender his partnership interest to the partnership in the event he

left.

     Immediately      following   the    transfers    of    assets   to   the

partnerships, the subsidiaries were liquidated.                As a result,

petitioner     obtained    the    subsidiaries’      limited    partnership

interests.

        On or about August 27, 1993, petitioner elected S corporation

status, effective June 27, 1993.        At the time of the election, no

changes were made to petitioner’s capital structure or to the

ownership interests in its stock.

Subsequent Transactions

     On November 1, 1993, Mr. Hanania acquired an additional 20-

percent limited partnership interest in CA Motors, Ltd., for

$179,707.     Subsequently, he purchased another 10-percent limited

partnership interest for $101,103.            Ultimately, on July 1, 1996,
                                     - 15 -

petitioner and Mr. Hanania entered into an agreement whereby Mr.

Hanania was given the right to acquire the Acura dealership over 7

years.   As part of the agreement, Mr. Hanania had the option to

obtain the franchise rights of the dealership for an additional

$700,000.

     In 1998, petitioner sold its 50-percent interest in the

partnership to Mr. Hanania for $2,397,500.              Mr. Hanania borrowed

the entire purchase price from petitioner, securing his loan with

his shares of stock in his solely owned corporation.

     On October 1, 1994, Mr. Seth purchased Mr. Andrews’ 5-percent

limited partnership interest in CN Motors, Ltd., for $201,138.

     On January 1, 1996, CN Motor Corp., CO Motor Corp., CH Motor

Corp., CA Motor Corp., and CFP Motor Corp. merged into CP-GMC Motor

Corp.    Simultaneously therewith, CP-GMC Motor Corp. changed its

name to CF Motor Corp.            As of that date, Mr. Coggin was the

majority shareholder (75 percent) of CF Motor Corp.                 Most of the

other 16 shareholders were key employees of petitioner; none of

these employees had an ownership interest greater than 4.5 percent.

     In 1997, petitioner agreed to sell the stock of CF Motor

Corp.,   as   well    as   the   assets   of   the   dealerships,    to   Asbury

Automotive    of     Jacksonville,   L.P.      (Asbury).    As   part     of   the

acquisition, petitioner agreed to sell to Asbury its 50-percent

interest in the Coggin-Andrews partnership.             Mr. Andrews objected
                                     - 16 -

to selling the dealership and filed a lawsuit seeking to block the

proposed sale.        Settlement negotiations followed, and ultimately,

Mr. Andrews agreed to sell his 50-percent interest in the Coggin-

Andrews partnership to petitioner and Asbury for approximately $7.3

million.

Notices of Deficiency

       In two notices of deficiency3 (one regarding tax year ended

June 26, 1993, and the other regarding tax years ended December 31,

1993, 1994, and 1995), respondent determined that pursuant to

section      1363(d),   petitioner’s    conversion     to   an   S   corporation

triggered the inclusion of the affiliated group’s pre-S election

LIFO       reserves   ($5,077,808)     into   petitioner’s       gross     income.

Respondent’s primary position was that the 1993 restructuring

should be disregarded because it had no tax-independent purpose.

Alternatively,        respondent   maintained   that   under     the     aggregate

approach of partnerships a pro rata share ($4,792,372) of the pre-S

election LIFO reserves was attributable to petitioner.                 Respondent




       3
          Before the issuance of the notices of deficiency,
respondent’s National Office issued a technical advice
memorandum, Tech. Adv. Mem. 97-16-003 (Sept. 30, 1996), which
concluded that petitioner would be subject to LIFO recapture
pursuant to sec. 1363(d) as a consequence of a change in its and
its subsidiaries’ structure.
     Technical advice memorandums are not binding on us. We
mention the issuance of the technical advice memorandum solely
for the sake of completeness.
                                - 17 -

concluded that under either theory, there was an increase in

petitioner’s     tax   liability,   payable   in   four   equal   annual

installments.4

                                OPINION

     Use of LIFO, vis-a-vis FIFO, often allows a taxpayer the

benefit of income deferral, particularly in periods of rising

inventory costs and stable or growing inventory stock.       The amount

of cumulative income deferral obtained through the use of the LIFO

method of accounting is represented in a taxpayer’s LIFO reserve.

     Section 1363(d) mandates recapture of the LIFO reserve upon

the conversion of a C corporation to an S corporation. In relevant

part, section 1363(d) provides:

          SEC. 1363(d).     Recapture of LIFO Benefits.--

          (1) In general.–-If–-

               (A) an S corporation was a C corporation
          for the last taxable year before the first
          taxable year for which the election under
          section 1362(a) was effective, and

                (B) the corporation inventoried goods
          under the LIFO method for such last taxable
          year,

     the LIFO recapture amount shall be included in the gross
     income of the corporation for such last taxable year (and
     appropriate adjustments to the basis of the inventory
     shall be made to take into account the amount included in
     gross income under this paragraph).



     4
          Pursuant to respondent’s alternative position, the tax
deficiency for the 4 taxable years under consideration is
$408,300.
                                       - 18 -

                        *     *        *      *      *      *    *

           (3) LIFO recapture amount.–-For purposes of this
      subsection, the term “LIFO recapture amount” means the
      amount (if any) by which–-

                (A) the    inventory   amount   of   the
           inventory asset under the first-in, first-out
           method authorized by section 471, exceeds

                (B) the inventory amount of such assets
           under the LIFO method.

Any increase in tax resulting from the application of section

1363(d) is required to be paid in four equal installments beginning

in the last taxable         year for which the corporation was a C

corporation.     See sec. 1363(d)(2).

      In enacting section 1363(d), Congress was concerned that a

corporation maintaining its inventory under LIFO might circumvent

the   built-in   gain   rules     of       section   1374   to   the   extent   the

corporation did not liquidate its LIFO layers during the 10 years

following its conversion from a C corporation to an S corporation.5



      5
       H. Rept. 100-391 (Vol. II), at 1098 (1987), in relevant
part, states:

           The committee is concerned that taxpayers
           using the LIFO method may avoid the built-in
           gain rules of section 1374. It believes that
           LIFO method taxpayers, which have enjoyed the
           deferral benefits of the LIFO method during
           their status as a C corporation, should not
           be treated more favorably than their FIFO
           (first-in, first-out) counterparts. To
           eliminate this potential disparity in
           treatment, the committee believes it is
           appropriate to require a LIFO taxpayer to
           recapture the benefits of using the LIFO
           method in the year of conversion to S status.
                                     - 19 -

       Respondent, relying on Frank Lyon Co. v. United States, 435

U.S.   561,      583-584   (1978),   takes    the     position    that    the    1993

restructuring “was not imbued with tax-independent considerations,

but was instead shaped solely by tax-avoidance features that have

meaningless labels attached.”           In this regard, respondent posits:

“The   1993      restructuring   was    conceived      and     executed    for   the

principal purpose of permanently escaping corporate level taxes on

the LIFO reserves built into the LIFO inventories of petitioner’s

former consolidated subsidiaries.”

       Petitioner disputes respondent’s assertion, maintaining that

the 1993 restructuring occurred in order to achieve tax-independent

economic and/or business desires of both Mr. Coggin and the general

managers.        We agree with petitioner.          The record reveals:           (1)

General managers were vital to the successful operation of the

automobile dealerships; (2) providing incentives to attract and

retain quality general managers was essential in the success of the

automobile dealerships; (3) operating the automobile dealerships in

stand-alone       partnership    form      afforded     the    general     managers

flexibility greater than that offered by operating the dealerships

in corporate form; and (4) Mr. Coggin and the general managers

never discussed recapture of the LIFO reserves.

       It   is   axiomatic   that    (1)   tax   considerations      may    play a

legitimate role in shaping a business transaction, and (2) tax

planning      does   not   necessarily      transform     an     event    otherwise
                              - 20 -

nontaxable into one that is taxable.   Here, Mr. Coggin sought the

advice of tax professionals–-both accountants and tax attorneys.

The legal opinion rendered by the law firm that Mr. Coggin engaged

did not address LIFO recapture.   The talking points paper prepared

by KPMG set forth the potential risk of LIFO recapture, as well as

a calculation of the potential tax liability, if section 1363(d)

applied.   Specifically, the document stated:

     LIFO inventory should not be recaptured on conversion of
     COIC [Coggin-O’Steen Investment Corp.] from a C
     corporation to an S corporation since COIC does not
     inventory any goods under the LIFO method for its last
     tax year as a C corporation (I.R.C. section 1363(d))
     (some degree of IRS risk which is being reviewed by our
     Washington National Tax practice).

But notably, the paper did not address the tax benefits of avoiding

the LIFO recapture.

     To conclude this aspect of our opinion, we find that the 1993

restructuring was: (1) A genuine multiple-party transaction with

economic substance; (2) compelled by business realties, imbued with

tax-independent considerations; and (3) not shaped solely by tax

avoidance features.   Cf. Frank Lyon Co. v. United States, supra.

Consequently, we reject respondent’s primary position that there

was no tax-independent business purpose for the 1993 restructuring.

We now turn our attention to respondent’s alternative position.

     For tax purposes, a partnership may be viewed either (1) as an

aggregation of its partners, each of whom directly owns an interest

in the partnership’s assets and operations, or (2) as a separate
                                      - 21 -

entity, in which separate interests are owned by each of the

partners.    Subchapter K of the Internal Revenue Code (Partners and

Partnerships)    blends       both    approaches.   In   certain     areas,   the

aggregate approach predominates.               See sec. 701 (Partners, Not

Partnership, Subject to Tax), sec. 702 (Income and Credits of

Partner).    In other areas, the entity approach predominates.                See

sec.   742   (Basis    of   Transferee     Partner’s     Interest),    sec.   743

(Optional Adjustment to Basis of Partnership Property). Outside of

subchapter K, whether the aggregate or the entity approach is to be

applied depends upon which approach more appropriately serves the

Code provision at issue.             See Holiday Village Shopping Ctr. v.

United States, 773 F.2d 276, 279 (Fed. Cir. 1985); Casel v.

Commissioner, 79 T.C. 424, 433 (1982); Conf. Rept. 2543, 83d Cong.,

2d Sess. 59 (1954).

       Respondent argues that the legislative intent underlying the

enactment of section 1363(d) requires the application of the

aggregate theory. Respondent asserts that Congress enacted section

1363(d) in order to ensure that the corporate level of taxation be

preserved on built-in gain assets (such as LIFO reserves) that fall

outside the ambit of section 1374.              In this regard, respondent

contends that failure to apply the aggregate theory to section

1363(d) would allow the gain deferred under the LIFO method to

completely    escape    the    corporate    level   of    taxation    upon    a   C

corporation’s election of S corporation status and would eviscerate
                                        - 22 -

Congress’    supersession     of    General      Utils.       &    Operating        Co.       v.

Helvering, 296 U.S. 200 (1935).

       Petitioner maintains that although there are no cases that

apply the aggregate or entity approach to inventory items, the

focus with respect to accounting for inventory is done at the

partnership level.       In essence, petitioner asserts that the LIFO

recapture    amount   under      section       1363(d)      is     a    component        of    a

partnership’s    taxable      income      that       must    be        computed     at    the

partnership level.      Petitioner posits that it would be incongruent

to treat the calculation of the LIFO recapture amount as an item of

income under the entity approach while applying the aggregate

approach to attribute the ownership of inventory to the partners.

Moreover, petitioner argues that section 1363(d)(4)(D) operates to

prevent the inventory of one member of an affiliated group from

being attributed to another member.

       To summarize the parties’ positions:                   respondent maintains

that   for   purposes    of   section      1363(d),         each        of   the   limited

partnerships (i.e., CP-GMC Motors, Ltd., CH Motors, Ltd., CN

Motors, Ltd., CA Motors, Ltd., CFP Motors, Ltd., and CO Motors,

Ltd.) should be viewed as an aggregation of its partners, and

consequently, petitioner, as a limited partner in each of the

partnerships,    is     deemed     to    own     a   pro     rata       share      of    each

partnership’s     inventory        of    automobiles             and     light     trucks.

Conversely,     petitioner       maintains       that       each       of    the   limited
                                       - 23 -

partnerships        should      be   viewed   as    a     separate   entity,    and

consequently, none of any limited partnership’s inventory or LIFO

reserve is deemed to be owned by petitioner or the other partners.

We agree with respondent’s position for the following reasons.

       In 1986, Congress enacted the Tax Reform Act of 1986 (TRA),

Pub. L. 99-514, secs. 631-633, 100 Stat. 2085, 2269-2282, which did

away with the General Utilities doctrine.                    (Under the General

Utilities doctrine, corporations              generally had not been taxed on

the distribution of assets whose fair market values exceeded their

tax bases.        See Estate of Davis v. Commissioner, 110 T.C. 530, 548

n.13 (1998).)       In TRA section 632(a), section 1374 (Tax Imposed on

Certain Built-In Gains) was amended to prevent the potential

circumvention of the corporate level of tax on the distribution of

appreciated (built-in gain) assets by a former C corporation that

held       such   assets   at    the   time    of   its    conversion   to     an   S

corporation.6 See Rondy, Inc. v. Commissioner, T.C. Memo. 1995-372

(“the original purpose of section 1374 was to support Congress’

repeal of the General Utilities doctrine”); H. Conf. Rept. 99-841

(Vol. II), at II-198 to II-199, II-203 (1986), 1986-3 C.B. (Vol.

4), 1, 198-199, 203.

       It became apparent that the goal of section 1374 was not being

achieved with respect to former C corporations that used the LIFO

       6
          In general, sec. 1374 requires an S corporation to pay
a corporate-level tax on any net recognized built-in gains
recognized within 10 years following the effective date of the S
election.
                                   - 24 -

method of accounting because a taxpayer that experienced rising

acquisition costs would seldom, if ever, experience a decrement of

its LIFO reserves.7         Congress thus recognized that the deferred

built-in gain resulting from using the LIFO method might escape

taxation at the corporate level.         In light of this potential for

abuse, section 1363(d) was enacted.          See H. Rept. 100-391 (Vol.

II), at 1098 (1987).

       After considering the legislative histories of sections 1374

and    1363(d), we conclude that the application of the aggregate

approach (as opposed to the entity approach) of partnerships in

this case better serves Congress’ intent.             By enacting sections

1374       and   1363(d),   Congress   evinced   an   intent   to   prevent

corporations from avoiding a second level of taxation on built-in

gain assets by converting to S corporations.            Application of the

aggregate approach to section 1363(d) is consistent with Congress’

rationale for enacting this section and operates to prevent a

corporate taxpayer from using the LIFO method of accounting to

permanently avoid gain recognition on appreciated assets.                In

contrast, applying the entity approach to section 1363(d) would

potentially allow a corporate partner to permanently avoid paying

a second level of tax on appreciated property by encouraging


       7
          See, e.g., Staff of Joint Committee on Taxation,
Description of Possible Options to Increase Revenues 189 (J.
Comm. Print 1987) (“[section 1374] may be ineffective in the case
of a LIFO inventory, since a taxpayer experiencing constant
growth may never be required to invade LIFO inventory layers”).
                                   - 25 -

transfers of inventory between related entities.8                  This result

clearly would be inconsistent with the legislative history of

sections 1363(d) and 1374 and the supersession of the General

Utilities doctrine.

      Courts have, in some instances, used the aggregate approach

for purposes of applying nonsubchapter K provisions. For instance,

in   Casel    v.   Commissioner,   79   T.C.      at   433,   we   upheld   the

Commissioner’s use of the aggregate approach for purposes of

applying     section   267   (disallowance   of    losses     between   related

parties).     In Holiday Village Shopping Ctr. v. United States, 773

F.2d at 279, the Court of Appeals for the Federal Circuit applied

the aggregate approach for purposes of determining the extent of

depreciation recapture to each shareholder.            Similarly, the Court

of Appeals in Unger v. Commissioner, 936 F.2d 1316 (D.C. Cir.

1991), affg. T.C. Memo. 1990-15, used the aggregate approach in

determining a taxpayer’s permanent establishment. In each of these

instances, the court analyzed the relevant legislative history and

statutory scheme in determining whether the aggregate or entity

approach was more appropriate.       Moreover, we are mindful that the

aggregate approach is generally applied to various subchapter K

provisions dealing with inventory and other built-in gain assets

      8
          Under sec. 704(c) the contributing partner is normally
allocated the “built-in” gain of the asset. However, if there is
no liquidation of LIFO layers, no gain or loss would be allocated
to a contributing partner who uses the LIFO method. This would
render sec. 704(c) effectively useless in allocating the built-in
gain deferred by the LIFO method of accounting.
                                 - 26 -

(i.e., receivables). See, e.g., secs. 704(c), 731, 734(b), 743(b),

751.

       We recognize that in several instances courts have found the

entity approach better than the aggregate approach.      For example,

in P.D.B. Sports, Ltd. v. Commissioner, 109 T.C. 423 (1997), this

Court used the entity approach for purposes of applying section

1056.     Similarly, in Madison Gas & Elec. Co. v. Commissioner, 72

T.C. 521, 564 (1979), affd. 633 F.2d 512 (7th Cir. 1980), this

Court and the Court of Appeals for the Seventh Circuit applied the

entity approach in determining whether expenses were ordinary and

necessary under section 162.       Likewise, in Brown Group, Inc. &

Subs. v. Commissioner, 77 F.3d 217 (8th Cir. 1996), revg. 104 T.C.

105 (1995), the Court of Appeals for the Eighth Circuit concluded

that the entity approach, rather than the aggregate approach,

should be used in characterizing income (subpart F income) earned

by the partnership.     We do not believe the holdings in those cases

to be dispositive here.      The outcomes in those cases were based

upon the specific legislative histories and statutory schemes of

the respective Code provisions at issue.       Each court viewed the

respective statute in the context in which it was enacted and

concluded that the entity approach was more appropriate than the

aggregate approach to carry out Congress’ intent. Here, as stated,

both the legislative history and the statutory scheme of section

1363(d) mandate the application of the aggregate approach.

        Finally, we do not believe that section 1363(d)(4)(D) operates
                                      - 27 -

to prevent the attribution of the dealership’s LIFO reserves to

petitioner.     Section 1363(d)(4)(D) provides:

          (D) Not treated as member of affiliated group.–-
     Except as provided in regulations, the corporation
     referred to in * * * [section 1363(d)(1)] shall not be
     treated as a member of an affiliated group with respect
     to the amount included in gross income * * *

Simply stated, section 1363(d)(4)(D) requires that a member of an

affiliated group that elects to be an S corporation be treated as

an independent entity for purposes of determining the amount

included in gross income.        Section 1363(d)(4)(D) requires only a

converting member of the affiliated group (rather than each member

of the affiliated group) to be responsible for the tax imposed on

the recapture of the corporation’s LIFO reserves.                     See S. Rept.

100-445, at 438 (1988).       Section 1363(d)(4)(D) does not prohibit

attribution of the inventory and LIFO reserves to petitioner in

this case.

     To conclude, we hold that the aggregate approach (as opposed

to the entity approach) better serves the underlying purpose and

scope of     section   1363(d)    in    the    circumstances     of    this   case.

Consequently,    petitioner      is    deemed    to   own   a   pro    rata   share

($4,792,372) of the dealerships’ inventories. Accordingly, we hold

that upon its election of S corporation status, petitioner was

required to include in its gross income its ratable share of the

LIFO recapture amount.

     In reaching our conclusions, we have considered carefully all

arguments made by the parties for a result contrary to that
                                     - 28 -

expressed herein, and to the extent not discussed above, we find

them to be without merit.

     The deficiencies set forth in the notices of deficiency are

based on petitioner’s failure to recapture its LIFO reserves of

$5,077,808 into its income.         Based on our holding that $4,792,372,

rather than $5,077,808, of the dealerships’ pre-S election LIFO

reserves     must   be   included    in   petitioner’s   income,   the   tax

deficiency    is    $408,300   (rather    than   $432,619),   pursuant   to

respondent’s alternative position, for each of the years under

consideration.      Accordingly,



                                                      Decision will be

                                                 entered for respondent

                                                 in the reduced amounts

                                                 for the years under

                                                 consideration.
