Why Did Developer Jackson Charge Nearly As Much As The Property For A “Consultant Fee” In Questionable Real Estate Deal?

A few days ago, this blog wrote about the big, messy lawsuit that now-Mayor (then-Developer) Jackson was involved in. In summation: Jackson’s company, Lorterdan at Ramapo, purchased close to 250 acres for $2,075,000, and later sold the property to Watchtower Bible and Tract Society of New York, a Jehovah’s Witnesses group, for $11,500,000, a 454% return on investment in just 7 years, without making any improvements to the property. The Jehovah’s faced some complications when applying for zoning, and coupled with problems in their attempts to get a tax exempt status, the group decided to ask Jackson to repurchase the property, as Lorterdan was required to do pursuant to their contract. Jackson agreed, but later reneged on his agreement and instead filed a lawsuit against the church.

While looking at some of the details from the Opinion & Order issued in the Lorterdan Properties v. Watchtower Bible and Tract Society of New York case, it stands out that a consulting fee of $9.5 million was required of the Watchtower group once they reached the decision to develop the land. The Watchtower group purchased the land for $11.5 million, so a consulting fee of $9.5 million, almost the total cost of the land, seems astronomical.

As was mentioned in the previous blog, the property was originally acquired by CHFM Associates, and was sold to Lorterdan Properties at Ramapo, LLC in 2002 for $2,075,000.

CHFM Associates is a New Jersey Partnership, founded by its partners Foun-Chung Fan, Wen-Hong Chen, Maurice Hsu, and Hsiu-Ju Mao. According to New Jersey’s business entity records, Foun-Chung Fan is also a principal at Lorterdan Properties at Ramapo, LLC. Jackson likely received the property at an extremely discounted rate because Fan also serves as a principal for Lorterdan.

So this brings us back to the question: why would Jackson ask the Jehovah’s Witnesses to pay, in addition to the $11.5 million purchase price for the property, an additional $9.5 million for “consulting fees?” According to the court, Lorterdan was required under the contract to provide “consulting services as required to secure zoning” for the Jehovah’s Witnesses over the course of two years. If we assume Jackson was engaged in these consulting services full time over the course of two years (not likely) the “consulting fee” would work out to $2,283.65 per hour. That is a pretty hefty fee, especially since whatever services Lorterdan did provide ultimately failed to get the property zoned.

            2,080 hours in a work year x 2 years=4,160 work hours in 2 years’ time

            $9,500,000/4,160= $2,283.65 per hour

It’s pretty clear that this “consulting fee” was probably not actually a fee paid for Lorterdan’s consulting services. It seems that it may instead simply be the second installment of the purchase price for the property, with some creative financial engineering behind it. Lorterdan’s own attorney referred to the $9.5 million dollar payment as the “second tranche” of the purchase price in a letter sent to the court. So, why would you break the purchase price of a property essentially in half and call the second installment a “consulting fee?” Well, one explanation might be to avoid paying some taxes. As this blog will explain in more detail below, it appears Lorterdan could have saved close to $200,000 in tax payments by essentially misrepresenting to the IRS what the $9.5 million payment was actually for.

This blog will only focus on the federal corporate tax rates, as there are too many variables to determine state and local tax rates. The principle is pretty simple: a large single transaction will be taxed at a high rate, but if you break the transaction into two smaller transactions and spread them over two years, those transactions will be each taxed at a lower rate, meaning you would pay less in taxes. This is the same reason that when people win the lottery, they often choose smaller payments made over 20 years rather than a single lump payment.

A number of assumptions are made here. First, it is assumed Lorterdan has elected to be taxed as a corporation. Lorterdan is an L.L.C. and can elect to be taxed as either a corporation or sole partnership. L.L.C.'s often elect to be treated as corporations for income tax purposes because they are generally subject to lower effective tax rates.

Lorterdan’s cost basis, or purchase price, for the property was $2,075,000. To find what the property gain was for Lorterdan, you have to take the sales price and subtract it from the basis. Without knowing a lot of the specifics, this example is just assuming that there is no depreciation, no capital improvements to the property, etc. This blog has a hunch why Jackson split the property up: the property’s value was originally intended to sell for $21,000,000 but by dividing up the costs into the $11,500,000 property costs and $9,500,000 consulting fees, Jackson would see lower corporate tax rates. Let’s take a look:

To calculate the federal corporate tax rate, you must subtract the sales price from the basis to get the property gain, which is the taxable amount. So let’s assume the property’s value is $21,000,000:

            $21,000,000- $2,075,000 (Lorterdan’s purchase price)= $18,925,000

The taxable rate for the property then would be $18,925,000. According to the federal tax rate schedule, any taxable income over $18,333,333 is automatically taxed at 35%.

So calculating the taxes on $18,925,000, Lorterdan would need to pay $6,623,750 in federal taxes.

By structuring the sale of the property at $11,500,000 and “consulting fees” of $9,500,000, Lorterdan would fall under a different tax bracket than if it reported the $21,000,000 sale price. So looking at the $11,500,000 property sale first:

            $11,500,000 - $2,075,000 (original purchase price)=$9,425,000

So following the rules of the corporate tax structure, Lorterdan would have paid $3,204,500 in taxes on the $11,500,000 property sale:

            $113,900+ ((9,425,000-335,000)(0.34))= Tax liability

$113,900 + (9,090,000)(0.34)

$113,900 + (3,090,600)= $3,204,500 Tax liability

Calculating the corporate tax amount on the $9,500,000 consulting fee is a slightly different calculation since it was a straight income. The taxable rate on the $9,500,000 consulting fee is $3,230,000:

            $113,900+ (($9,500,000-335,000)(0.34))= Tax liability

$113,900 +($9,165,000)(0.34)

$113,900 + ($3,116,100)= $3,230,000 Tax liability

So adding up the taxed portions on the land and consulting fees, Lorterdan likely would have to pay $6,434,500 in taxes:

$3,204,500+$3,230,000=$6,434,500

Now if Lorterdan had reported to the IRS that the sale price was $21,000,000, they would have paid $6,623,750 in taxes, but instead they likely decided to divide the property up into two chunks- the property price and the “consulting fee” for a total of $6,434,500 in taxes. The difference between the straight sale of the $21,000,000 and the $11,500,000 +$9,500,000 “consulting fee” is $189,250.

            $6,623,750- $6,434,500= $189,250.

By dividing the property into two separate payments, Lorterdan would 1). spread out the taxes over the course of two years instead of one and 2). pay less in corporate taxes. By structuring the deal this way, Lorterdan could have saved $189,250, by these estimates.

Based on the corporate tax structure, it could have been cost-effective for Lorterdan to split the costs into two separate payments as they did. This blog is also assuming that the $9,500,000 in “consulting fees” were being taxed at the corporate rate. If either Fan or Jackson pocketed that amount, it would be taxed at a private rate, which is less than the corporate amount. Obviously, there are a lot of variables at play here, but this scenario suggests that the deal was set up to help Lorterdan save on taxes by misleadingly classifying income.

This blog made numerous assumptions and simplifications here, but the $9,500,000 consulting fee is very strange and should be questioned and investigated by others that might know these issues better.