Transferee liability

Transferee Liability

April 23, 2015 | By Keith Martin in Washington, DC

Transferee liability can make the selling shareholders of a company liable for taxes the company should have paid, but that the new owners failed to have it pay.

Four individuals owned a regular “C” corporation called Little Salt Development Co. whose sole asset was 160 acres of land near Lincoln, Nebraska that was used for farming and duck hunting. The corporation sold the land to the city for $472,000 in June 2003, receiving $471,111 after subtracting settlement costs. The corporation had a taxable gain on the land of $432,148.

MidCoast Investments approached the shareholders with an offer to buy the company for $358,826, or the cash in the company, less 64.92% of the tax liability on the capital gain, and said it would cause the company to file a return to pay the taxes owed on the land sale.

The transaction closed in August 2003.

The shareholders figured they were better off by $58,842 by taking the offer compared to keeping the proceeds that would have remained from the land sale after paying taxes.

MidCoast failed to have the company pay the taxes it owed. The IRS assessed back taxes against the company and, when it was unable to collect, went after the former shareholders.

Section 6901 of the US tax code authorizes the IRS to pursue any remedies it has under state law to collect taxes where property is transferred fraudulently to avoid creditors. Nebraska has adopted the Uniform Fraudulent Transfer Act. That statute treats a transfer as fraudulent as to present creditors whose claims arose before the transfer if reasonably equivalent value is not received in exchange and the debtor was insolvent at the time or became insolvent as a result of the transfer.

All the elements of a fraudulent transfer were present in this case. The IRS had a claim against Little Salt Development Co. for taxes before MidCoast bought the company. Little Salt received no value. It had an estimated tax liability at the time of $167,737. The transaction left it insolvent because MidCoast immediately stripped all the cash out the company by purporting to borrow it in exchange for an uncollectable note that it left in the company.

Thus, the transfer was fraudulent against the IRS.

Nebraska law allows a creditor to go after “the person for whose benefit the transfer was made.”

The US Tax Court said the IRS could force the former shareholders to pay the amount they benefited — $58,842 — but not otherwise to pay the full taxes of the company.

The case is William Scott Stuart, Jr. v. Commissioner. The Tax Court released its decision on April 1.

by Keith Martin in Washington