Seems like everything becomes a tax story eventually and so it goes with the colorful controversial Jack H Owoc and his Vital Pharmaceuticals best known for its Bang Energy line of drinks. There has been controversy about the Pepsi distribution deal, what exactly is it that goes into those drinks, the massive lawsuit by Monster Inc and whether certain social media accounts belong to the company or Owoc personally. Bang had made it to third among energy drinks by an aggressive digital marketing effort. My part of the story is perhaps not as exciting, but it does have some interest.
Joshua Schall has been covering the overall story on YouTube.
The bankruptcy of Vital Pharmaceuticals seems to be heading toward liquidation after a massive asset sale to Monster. The sale may generate a substantial tax. Does that come out of Owoc’s pocket or do the unsecured creditors bear the burden?
About Vital Pharmaceuticals
Vital Pharmaceuticals (VP) was established in 1993. Headquarters are in Weston, FL. The company is involved in “sports nutrition” and “performance energy drinks”. By the account of Chief Transformation Officer John C. DiDonato the Company produces “novel and great tasting beverages without sugar, calories, carbohydrates, or artificial flavors”. Rather there is caffeine, electrolytes and other performance ingredients. The leading product was Bang. Bang was launched in 2012 and by 2022 was third best-selling energy drink in the United States.
VP has historically been profitable. In 2019 it had earnings of $175 million on retail sales of $1.2 billion. The company has had an aggressive digital marketing structure including TikTok, Facebook, Instagram and YouTube. According to DiDonato the company was working with approximately 1,000 influencers and its social media marketing efforts reached 1.3 billion followers.
There is a chance that you are today years old when you are hearing about Owoc and Bang. Danny Gonzalez in that video is not quite thirty years old. His channel has over a billion views. As I was working this story there was a major family event where I got to talk to people from age 3 to 76. The ones around the midpoint and younger had at least heard of Bang and knew about its social media presence. The boomers were clueless.
In 2020 VP entered into a distribution agreement with Pepsico, which it tried to terminate seven months later. Pepsico resisted and there were various legal proceedings. They finally settled on June 21, 2022. As of the date of the bankruptcy petition in October 2022 the transition to an independent distribution system was still in progress.
The distribution problem was a big setback, but what really sent VP and the related entities into bankruptcy was a lawsuit by competitor Monster Beverage
MNST
The Tax Issue
Since going into bankruptcy in 2022 VP has been losing a lot of money. Now when an individual goes into bankruptcy, a new taxable entity is created called the bankruptcy estate. That’s not the case with a corporation. It continues as the same taxable entity.
Historically Jack Owoc, the founder and sole shareholder had served as the sole director and CEO and managing member of affiliated entities. The bankruptcy led to an expansion of the board and ultimately Owoc’s dismissal as CEO. He remains the sole shareholder, though which is what has created the tax dispute. Although he is still the sole shareholder he is no longer in charge. And that has the bankruptcy court ruling on tax elections.
VP is an S corporation. Generally an S corporation does not pay corporate income taxes. Income and losses “flow through” to the returns of individual shareholders. Distributions to shareholders are generally not taxable to them. There is a very important concept called “basis”. Basis puts a limit on how much loss can be allocated to a shareholder or how much they can withdraw tax free and is part of determining their gain or loss on sale or liquidation. When I started this story I was afraid that I was going to have to explain basis to you. It turns out that Mr. Owoc has plenty of basis, which implies that he was leaving a lot of profits in the corporation over the years. If you are curious about basis you can read my What Is Basis And Why It Is Important.
What Mr. Owoc wants is VP to terminate its S election. When an S election terminates during a tax year some income or loss is allocated to the shareholders and the rest is taxed to the corporation which is henceforth a tax paying entity. The default method for the allocation is based on a ratio of days in the year before and after the revocation. Roughly speaking early July will give you a fifty fifty split. Earlier in the year will mean more goes to the taxable corporation. Later in the year means more goes to the shareholders.
Mr. Owoc does not want the default method. He wants the corporation to elect to do an interim closing of the books. The cutoff will be before the Monster sale, which is at a big gain, is finalized. Judge Peter D. Russin ruled against Owoc’s motion to accomplish this on October 6. Owoc has requested a hearing to be conducted on October 31, not expecting a favorable outcome, but to preserve appellate remedies.
Some Numbers
Reilly’s Sixth Law of Tax Planning – Don’t so the math in your head. The debtors figured that Owoc’s maneuver would be a bad deal for them, but they wanted to know how bad. Attached to their motion in opposition is a report by Richard E Cabrera JD CPA, Director of Tax Services at Berkowitz Pollack Brant in Fort Lauderdale Fl. The report starts on page 27 of the pdf. The report lays out estimates of the tax payable by Owoc if the sale goes through with the S election still in force and what happens if the election is terminated with or without the closing of the books election. In addition the report gets into future tax benefits that Owoc might be able to use.
When Cabrera did the report the expectation was that the $371 million asset sale to MBC that closed on July 31, 2023. Normal people won’t understand this, but this was a really cool assignment. When I was younger and sharper I would have really relished doing it.
Cabrera computed that if Owoc got both his wishes, the corporation would face a $27.5 million dollar tax as a result of the sale. Owoc would not be at all liable for the tax on the sale and would have a flowthough loss of $22 million from the activity prior to the sale. Upon liquidation Owoc would have a capital loss of $50 million from deducting his remaining basis in the corporation.
If neither of Owoc’s wishes are granted he would have a liability of “approximately” $3,438,1444 as a result of the sale and liquidation. He would have a net capital loss carryforward of $49 million and a remaining NOL carryover from 2022 of $23 million.
The one wish scenario is a termination of the S election without the closing of the books election. Under a pro rata allocation Owoc would have a tax liability for 2023 of $10 million and the corporation would owe $9.2 million.
If Owoc had terminated the S election immediately before the bankruptcy more losses would have gone to the C corporation reducing its ultimate tax from $27.5 million to $19.1 million.
I really wish that I had Mr. Cabrera’s workpapers and a week or so with nothing else to do, because these numbers don’t feel right to me. VP has always been an S Corporation so if it finishes its life with Mr. Owoc getting nothing I would expect him to have zero basis at that point, not $50 million or so of left over basis that gives him a capital loss to carry over to use against future capital gains or to offset ordinary income at the rate of $3,000 per year for the next 17,000 years or so. Of course this is a much more complex entity than most of the S Corporations I have worked on over the years. Feel free to mock me in the comments section for missing the obvious explanation that you perceive.
According to the court’s decision Mr. Owoc’s expert painted a much darker picture for him with a tax liability that could range between $95.6 million to $197.4 million. I can’t begin to grasp the debits and credits that are going on there.
What The Judge Ruled
One of the beefs that the creditors had with the attempt at the election was that Mr. Owoc waited until the last minute to raise it. That prejudices VP since they might have negotiated the sales deal differently if they knew the tax would be coming out of what went to the unsecured creditors. Judge Peter D. Russin ruled that the delay by Mr. Owoc was not inexcusable. He would not have known about his potential tax problem until late in the game and the possible changes that VP might have negotiated were speculative. Overcoming that obstacle did not win the case for Owoc.
Judge Russin sank Owoc’s plan by ruling that S status is property of the bankrupt entity not of the shareholder. S status is elected by the corporation with the consent of the shareholders. It is the same with the revocation of S status. And the close the books election is a corporate election. In making the ruling Judge Russin was critical of a Third Circuit decision, In re Majestic Star Casino. The facts were somewhat different there as the bankrupt entity was a QSub and the owning entity which was not in bankruptcy triggered the end of QSub status by revoking its own S election.
What’s Next?
Owoc has filed an appeal in the district court this week. It is a little puzzling as to how this will play out, if he prevails. It is too late to make the election that he is arguing for effective when he wants it. Another way to have terminated the S election would be for Owoc to have transferred any amount of stock to a non-qualified shareholder. Perhaps that was done subject to obtaining court approval.
This case would probably make for a good problem for a Masters In Taxation test.
There is quite a bit of coverage of the bankruptcy litigation, but I have not found any discussion of this income tax issue.
Read the full article here
