The point is, if you can dream up a way to do an end run around the tax law, then so has the IRS and they’ve also written rules to prevent it.
Beside, the kids have to buy their land at fair market value; which over a dozen or two parcels, with the relative odds of finding oil, probably adds up to the same total value as before drilling. Can you really buy random plots where oil is known to likely exist and not pay close to proven oil land value? Or you find no oil, and all the land is dud now.
What are the rules about drilling near the boundary between properties and possibly sucking out the neighbour’s oil?
I quite agree. Maybe I could have chosen a better example. But my main point was that the lawsuit doesn’t change anything about the tax status of the transaction. So, lets’ s change the last sentence to be:
“In both cases, from the tax perspective it’s still a putative purchase that’s an obvious attempt to skirt the gift tax and the IRS will want the parents to pay gift taxes.”
[Though now I’m thinking, it would take a pretty determinedly incompetent lawyer for the parents to lose the lawsuit. “Look Judge, if this is a real purchase and not a gift, why does IRS want us to pay gift tax on it? And the promise of a gift can be rescinded at any time.” ]
Why does the lawyer have to be incompetent to lose the lawsuit? Remember that the terms of the ‘family business’ are murky because there is no business plan and there could have been any number of verbal promises made by the parents to the kids that didn’t pan out resulting in the lawsuit. The parents agree what they did was ‘wrong’ (whatever it was) and want to settle for the $100M. In my scenario, the lawyers on both sides are also colluding, so presumably they can make up some really nasty bullshit and both agree to it.
Besides, if it settles outside of court, do you have to disclose what the issue was even about? Maybe it is something embarrassing that you don’t want getting into the public record. Couldn’t that be the goal of settling the lawsuit (assuming no party is accusing the other of blackmail or other issue?). Again, remember that in my scenario, the parents, kids, and lawyers are colluding to avoid or lessen the taxes they have to pay on the $100M.
You won’t have to disclose anything on the original tax return.
However, the IRS can demand (under subpoena) the documentation to back up the expense. If you cannot provide documentation, or cannot provide sufficient documentation, they have the legal authority to change the amounts on your returns and assess tax based on the changes.
Your attorney actually can refuse to provide testimony or documentation as part of attorney-client privilege. You can refuse to provide it yourself. But without any documentation, the IRS is going to say “We think this is a gift. You have no documentation otherwise. Here’s your tax bill.” (Heck, they might even escalate it to tax fraud if they think they can show intent.)
If someone used this tactic to cheat for small amounts, they’d probably even get away with it (at least for a few years) because the IRS doesn’t audit very many returns.
Move to Canada - no gift tax. You got your hands on the money, you already paid your taxes on it, if you want to gift it to someone, if you’re handing out free money, that’s your problem.
(I assume that you may have to renounce your US citizenship to escape US taxes, unless gifts only count inside the USA?)
On the big picture, once again, from a tax perspective, having a lawsuit doesn’t change anything.
If everyone gets together and dreams up a business situation where the kids are owed $100M, then the parents can just cut them a check and tell the IRS “we owe them this for <complicated reason X>” and hope the IRS buys it. If everyone conspires to go ahead with a fake lawsuit then in the end the judge orders the parents to cut a check for $100M, the parents do so, tell the IRS “we owe them this for <complicated reason X>”, and hope the IRS buys it. Tax-wise, the IRS doesn’t care whether the parents were ordered to or not.
When I mentioned it would be hard for the parents to lose, I was referring specifically to the ‘Buy your child’s fingerpainting for $100M’ scenario. This is a long tangent, that’s probably not helpful to the OP, since the big point is that the lawsuit doesn’t matter, but there’s a legal doctrine that you need both sides to get something of value to make a contract, and so a promise of a gift isn’t a legally enforceable contract. If the parents signed an agreement to buy the fingerpainting for $100M then backed out, the kids wouldn’t have a legal leg to stand on if they tried to sue for the $100M (and there was any even remotely competent attorney on the parents’ side). The parents would simply say ‘this is clearly not really a fair market transaction; it was just a gift from us to the kids. Since it was a gift, there’s no real contract and they can’t enforce it.’
Fair enough, but if you are telling the IRS “we owe them this for <complicated reason X>”, presumably you need to back that up with some evidence to prevent lots of investigating into the tax fraud that was committed. I would argue that having a fake lawsuit that settles is exactly the kind of evidence you want. The idea being that you don’t want to make it look like you willingly gave your kids the $100M where the IRS would view it as a gift. If the $100M was given under some situation where it seems clear they didn’t want to give it, then it seems plausible as a deductible amount you can take from your taxes, at least for the parents…
It’s just that if you can forge enough false documentation to carry out a whole sham trial, then you’ve got way more than enough false documentation to give the IRS anyway, so why bother with the sham trial?
The IRS won’t care if you say “We didn’t want to, but we wrote the check because the judge ordered us to” or if you say “We didn’t want to, but we wrote the check because our lawyers told us we had to (or we’d lose in court)”.
Quartz, you are correct that Jeffrey Archer already wrote a story with this idea as the central twist and most of it takes place at a golf club. In the story, one man successfully sues his friend for slander for remarks he made publicly at a golf club, and at the end, it is revealed that it was all a scheme to transfer a large amount of money without incurring gift tax (and in Britain, apparently, the recipient of a cash verdict does not have to pay income tax on it, either).
It’s a pretty good story, written a while ago (Archer’s most recent stories have shown a dramatic drop in quality IMO).