The field of tax is usually not regarded as being an outlet for exceptional creativity.
In fact, in our society, there is a general impression that people who work in the field of tax — i.e. accountants, tax lawyers, auditors and so forth — tend to have personalities which are on the more “boring” side of the spectrum. As with so many other impressions based on a superficial reading of the situation, this impression fails to fully reflect the reality of the situation. The truth is that working with the tax code permits creativity to a very high level, but such creativity can only be possible when a high level of technical mastery has been achieved. Moreover, a considerable amount of mental horsepower is required, because one has to be able to extrapolate, draw inferences and see connections between things that may not always be readily apparent to the casual observer. If one has a certain degree of mental suppleness, combined with high level technical competency, the opportunities for creative expression are plentiful.
In some cases, the creativity displayed by those in the field of tax can provide valuable lessons for other professionals. This is particularly true when the creativity ultimately leads to litigation. If we study the creative slip-ups and missteps that landed a given person in court, then we can learn from past mistakes to ensure that we able to better serve clients and make substantive contributions to the field in the future.
The case of Kornfeld v. Commissioner (1998) is not currently a piece of standard material for first-year law students, nor is it regularly studied by accountants or other tax professionals, but it should be. No matter what type of professional you are — a New York tax attorney, Cleveland-based CPA or Detroit debt resolution specialist — you should take the time to commit this case to memory.
In this case, a very experienced tax attorney, Kornfeld, used a bit of creative maneuvering to try and develop an entirely new type of investment property. By examining this case in detail, we can see that the field of tax allows for all sorts of possibilities provided that one has the requisite intelligence and knowledge. However, this case also shows that it’s extremely important that professionals go the extra mile and conduct sufficient research to ensure their strategies will hold up when examined by a judge.
The Facts of the Case
When someone purchases a bond, this asset is not depreciable, because the bond’s cost basis is reduced incrementally over the course of its life. If a bond owner were able to take depreciation deductions throughout the term of the bond, this would have to be considered a windfall for the owner, because the owner would receive payments on top of the deductions and the cost basis would still exist as normal.
In this scenario, Kornfeld thought he had devised a rather clever scheme to effectively create a depreciable bond and grant himself a windfall. To do this, instead of purchasing the bond outright in a straightforward sale, Kornfeld attempted to purchase a life estate interest in the bond, because this would seemingly create a limited term interest that would be depreciable.
The transaction went as follows: Kornfeld established a revocable trust through which he intended to buy the bond; he then entered into agreements with two of his daughters whereby his daughters were to hold the remainder interests in the bond. Kornfeld used IRS valuation tables to estimate the approximate value of his life estate interest. Based on these estimates, Kornfeld’s daughters contributed funds to the revocable trust in amounts consistent with their remainder interests, and then Kornfeld gave both of them checks to cover these exact amounts.
Right away, we can see the impressive level of creativity in Kornfeld’s elegantly devised transaction. Kornfeld’s scheme, while deceitful, clearly required a firm grasp of underlying principles, and also a creative talent to combine things that are otherwise totally separate. This attempt to create a new financial product by combining disparate elements together, though unsuccessful, undoubtedly requires great intelligence and a prodigious work ethic. There are plenty of lessons to be drawn from this tax attorney’s misdeeds in this case.
Why Kornfeld Should Be Standard Material
The court examined Kornfeld’s actions and determined that the step transaction doctrine could be applied. Not only did Kornfeld create a “nonentity” in the sense that a genuine life estate interest in a bond cannot exist, his dealings with his daughters (and later his secretary) clearly demonstrate that he had acquired full ownership of the bond. Though Kornfeld’s daughters contributed funds to the revocable trust, they received payments to cover these contributions, and so it’s obvious they didn’t create a valid contractual relationship with regard to the bond. Kornfeld v. Commissioner is therefore a prime example of the necessity to conduct adequate research before attempting to seize on an otherwise brilliant creative impulse. The cleverness of Kornfeld’s plan is impressive, but if he had thoroughly investigated all possible objections, he would have known that his scheme was not likely to survive legal scrutiny.
Kornfeld v. Commissioner shows that, no matter how clever one may be, there’s no substitute for doing adequate research. This case also reinforces the basic notion that the spirit of the law ultimately prevails, even when great creative energy is expended to comply with letter of the law. In theory, there are many other financial nonentities that could be created to provide all sorts of amazing benefits to consumers, but allowing this type of creative maneuvering would go against societal principles of equity. This case also provides an excellent opportunity for all tax professionals to become familiar with the mechanics of the step transaction doctrine. All tax professionals need to understand how this doctrine works; otherwise they or their clients could end up in court just like Kornfeld.