The Internal Revenue Service is demanding $2.7 million in extra taxes and penalties from race car driver Juan Pablo Montoya, who, it asserts, had $9.5 million in taxable income in 2007 and 2008, nearly four times the $2.4 million he and his wife reported on their joint tax returns for the two years.
In a previously unreported lawsuit filed in U.S. Tax Court, Montoya concedes that in those two years he had nearly $800,000 more in gross receipts, interest and partnership income than originally reported, but challenges the IRS’ other, even bigger dollar adjustments.
Montoya, a 38-year-old Colombian citizen who now lives in state and local income tax free Miami with his wife, Connie Freydell, and three children, is hardly the first driver to run into trouble with the IRS. Coincidentally, he recently signed to drive in 2014 on the IndyCar team of Roger Penske, the billionaire CEO of Penske Automotive Group.
That team already includes Brazilian Helio Castroneves, who placed second this year on the IndyCar circuit and is known beyond the track for winning Dancing With The Stars and for his 2009 jury acquittal on federal felony tax fraud charges.
While the details are very different, both drivers’ tax disputes involve offshore corporations and payments for use of their images—elements that were also at the heart of past IRS challenges to golfers Sergio Garcia and Retief Goosen and are an issue in Spain’s current pursuit of Barcelona football star Lionel Messi.
That’s not surprising; Apple, Google, Facebook and other companies have used ploys involving intellectual property and corporations in Ireland and other tax havens to divert profits to these locales and cut their worldwide tax bills.
Castroneves’ criminal trial centered around $5 million in licensing and image income that he said he had legitimately deferred and the government alleged he tried to illegally hide offshore. After his acquittal, Castroneves immediately recognized $15 million in deferred income, paying $5 million in tax.
The IRS demanded another $6 million in taxes and civil fraud penalties, but according to a previously unreported U.S. Tax Court stipulated decision entered in January, settled for under $260,000, with no fraud penalties collected.
The biggest dollar issue in Montoya’s case is a fancy maneuver involving the rights to his image that he undertook before moving to the U.S. in 2007 to compete in NASCAR for Earnhardt Ganassi Racing. (Montoya has had an unusually varied career.
He raced on a Formula 3000 team in 1997 and 1998, moved to the U.S. and won the CART championship in 1999 and the Indianapolis 500 in 2000, moved to Monaco and Formula One racing in 2001, then jumped to NASCAR in 2007.)
According to Montoya’s lawsuit, on the advice of his father/manager, in 2001 he contributed his name, appearance, likeness, image, voice and bio —his “Driver Identification”—to JPM Motorsport, Inc., a Bahamas corporation owned by a Bahamian trust his dad had set up for him in 1999.
At that point in 2001, his lawsuit says, he was racing Formula One for BMW and living in Monaco, with no plans to move to the U.S. (Monaco has long been a favored tax haven for Formula One drivers.) But after a disappointing Formula One season in 2006, he agreed to move to the U.S. and NASCAR for the 2007 season.
In preparation for the move, his lawsuit says, Montoya and his father consulted with tax advisors in the Bahamas and United States and were advised to “domesticate his foreign assets to the United States.” So he set up Monty Motorsport LLC, a Delaware limited liability company. (Delaware is a favored haven within the U.S. for shielding intellectual property income from state tax.)
Here’s where it gets interesting, becoming either a sham (the IRS view) or a clever, if aggressive, tax arbitrage between Montoya’s status as a non- U.S. resident in 2006 and a U.S. resident in 2007. In 2006, Montoya’s JPM Motorsport sold his Driver Identification to his Monty Motorsport for a $15 million note.
Monty Motorsport then began amortizing (writing down the value of) its $15 million investment, claiming a deduction of $1.4 million in 2007 and $1 million in 2008. The IRS disallowed the deductions, listing six possible grounds on which they could be thrown out, including that all the related party transactions were a sham and that their principal purpose was to “improperly claim amortization deductions in self-created intangibles and to artificially create basis for such deductions.”
Montoya’s tax lawyer declined comment for herself and her client. But Miami tax lawyer David M. Garvin, who represented Castroneves in U.S. Tax Court, came to the defense of such tax arbitrage. Rules written to keep U.S. taxpayers from playing games “may end up giving a non U.S. taxpayer a benefit that was not foreseen, ‘’ he said. “But that doesn’t give the IRS the right to rewrite the law simply by calling something a sham.”
Not surprisingly, the IRS also gave thumbs down to another ploy Montoya used to convert the hefty professional fees he incurred in 2006, when he wasn’t a U.S. taxpayer, into a tax deduction for 2007, when he was. In 2006, he personally paid the $267,000 in expenses the Bahamas trust incurred in connection with the Driver Identity sale, treating it as a loan to the trust.
In 2007, when Montoya became a U.S. resident, the Bahamas trust, under U.S. tax law, legally became a “grantor trust”—meaning all its income and deductions get reported on Montoya’s personal 1040. So in 2007, the trust repaid Montoya the $267,000 by reducing the balance on the note owed by Monty Motorsport by that amount and Monotoya then deducted $267,000 as passed through expenses from his Bahamas grantor trust in 2007.
Of course the IRS plays “heads I win, tails you lose” too. Although it wants to ignore the 2006 Driver Identity sale as a sham, it also contends that the transaction was an installment sale by a grantor trust and that Montoya must recognize a total of $2.5 million in income from the sale in 2007 and 2008.
His lawyers respond that since Montoya wasn’t a resident in 2006 when the sale took place, the grantor trust rules which would require such income recognition don’t apply.
Still, the IRS has nothing on Montoya and his advisors when it comes to chutzpah. In yet another move the IRS disallowed, Montoya used his changing residential status to claim extra tax breaks for his purchase of an $8.7 million Lear Jet to fly to NASCAR races around the U.S.
He formed a C corp in 2006 to buy the jet and then liquidated the C Corp in 2007 and put the jet in an LLC. According to Montoya and his lawyers, the liquidation generated a $100,000 operating loss and $150,000 capital loss for him, as well as a bigger basis in the jet to depreciate. They argue he had a legitimate residence related reason for this maneuver too: according to FAA regulations a non-U.S. person cannot own a U.S. airplane directly and must use a C corp.