Shareholders Benefitting from Asset Transfer Only Partially Liable for Unpaid Taxes.

(Parker Tax Publishing April 23, 2015)

The Tax Court held that shareholders who transferred all of their corporation's cash to a third party, without first paying corporate taxes, were liable as transferees for the unpaid taxes. However, the court found that under state law the shareholders were only liable for the amount of the benefit they received from the transaction. Stuart v. Comm'r, 144 T.C. No. 12.

Background

Little Salt Development Co. (Little Salt or company), a C corporation, owned 160 acres of saline wetlands on the outskirts of Lincoln, Nebraska. In 2003, it sold the land for $471,111 to the Nebraska Game and Parks Commission, who were interested in protecting the habitat of an endangered beetle species. During negotiations leading up to the land sale, Little Salt's shareholders were contacted by MidCoast Investments, Inc. (MidCoast). MidCoast represented that it would purchase the Little Salt shares and would pay the shareholders significantly more than they would otherwise receive if they dissolved the company and receive the land sale proceeds in redemption of their shares.

The letter specified that, in exchange for Little Salt's cash on hand, MidCoast would purchase the shares for the value of the cash less 64.92 percent of the outstanding tax liability. The letter also contained a covenant under which MidCoast would "cause" Little Salt to pay the outstanding tax liability. Little Salt's accountant calculated the unpaid 2003 tax liability to be $167,737. He determined that 64.92 percent of that amount was $108,895, which he subtracted from Little Salt's cash balance of $467,721, to arrive at the purchase price of $358,826. Little Salt transferred its cash balance to the trust account of a local lawyer retained by MidCoast, leaving Little Salt with no cash and no tangible assets. MidCoast then transferred the cash in the trust account to a bank account created in Little Salt's name, and the next day, the cash was transferred out of that account and to a MidCoast account and recorded on Little Salt's balance sheet as a shareholder loan.

Despite MidCoast's covenant, Little Salt paid no taxes on its 2003 return. The IRS subsequently determined a deficiency in Little Salt's 2003 federal income tax of $145,923 and sent letters to the shareholders informing them that they were considered liable as transferees for the unpaid taxes.

Analysis

Code Sec. 6901 authorizes the IRS to proceed against the transferees of delinquent taxpayers to collect unpaid tax debts. In order to do so, the IRS must first establish that the target for collection is a "transferee" of the delinquent taxpayer within the meaning of Code Sec. 6901 and then must show that the transferee is liable for the transferor's debts under state law (Comm'r v. Stern, 357 U.S. 39 (1958)). The term "transferee" is defined broadly to include any donee, heir, legatee, devisee, or distributee (Code Sec. 6901(h)).

Under Nebraska state law, a transfer is fraudulent with respect to a creditor where (1) the creditor's claim arose before the transfer, (2) the transferor does not receive "a reasonably equivalent value in exchange for the transfer," and (3) the transferor was insolvent as a result of the transfer (Neb. Rev. Stat. Ann. sec. 36-706(a)).

The Tax Court observed that, for purposes of Nebraska law, the term "claim" means "a right to payment," and prior to the transfer, the IRS had a claim against Little Salt for the unpaid taxes stemming from the land sale.

The court then found that Little Salt did not receive value reasonably equivalent to the $467,721 that it transferred to MidCoast's lawyer's trust account because, under state law, a debtor (Little Salt) does not receive reasonably equivalent value if it makes a transfer in exchange for a benefit to a third party (the shareholders). Additionally, the court noted that whatever value might be assigned to MidCoast's covenant to "cause" Little Salt to pay the $167,737 tax liability could not exceed the value of the liability, which was far from being substantially equivalent to the $467,721 that Little Salt transferred to the trust account. Moreover, the court reasoned a covenant to "cause" a corporation to pay its liabilities was essentially meaningless and valueless since MidCoast did not promise to pay the liabilities itself, and Little Salt lacked the assets to pay.

Next, the court determined that because Little Salt transferred its entire cash balance, it was left with no assets with which to pay its outstanding tax liability, rendering it insolvent. As Little Salt had received no equivalent value for the transfer, and as it was insolvent because of the transfer, the court held the transfer was fraudulent, finding that the shareholders were liable under state law to the IRS as "persons for whose benefit" Little Salt made the transfer to MidCoast. Thus, the tax court held the shareholders were transferees within the meaning of Code Sec. 6901, and the IRS could recover from them.

However, the court found scant Nebraska state authority addressing the measure of recovery in cases where the transferees were "persons for whose benefit" the transfer was made, and instead relied on its decision in Sawyer Trust of May 1992 v. Comm'r, T.C. Memo. 2014-59 to determine that the shareholders were liable only for the benefit they received from the transfer, rather than the full amount of the unpaid taxes.

The court noted that the shareholders' benefit from the transaction with MidCoast was $58,842: the $358,826 that MidCoast paid for their shares, less the $299,984 that Little Salt would have distributed to the shareholders had it paid its tax liability and redeemed the shares. Although $58,842 was substantially less than the unpaid tax, the Tax Court held that was the amount the shareholders owed the IRS.

For a discussion of transferee liability, see Parker ¶262,530. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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