On February 7, 2022, the Tax Court issued a Memorandum Opinion in the case of Slone v. Commissioner (T.C. Memo. 2022-6). The primary issues presented in Slone were (i) whether the IRS bore the burden of production to show timely supervisory approval of the accuracy-related penalty; (ii) whether the IRS was entitled to maintain claims against the petitioners and the trusts at issue.
Editor’s Note to Slone v. Commissioner
The contempt that Judge Lauber (appropriately) has for the Ninth Circuit Court of Appeals is palpable in this opinion. As you can see from this history of this case, the Tax Court and the Ninth Circuit had a veritable measuring contest, and, sadly, the Ninth Circuit won (most of) the day. Because, you know, Article I supremacy.
That doesn’t mean Albert Lauber is going to take it without a few jabs, though. Kudos, Judge Lauber. Stick it to the hippies.
These cases involve the assertion by the IRS of transferee liability against the petitioners as transferees of a corporation that was stripped of its assets and left unable to satisfy its Federal tax obligations. In a previous case, the Tax Court ruled that the petitioners were not transferees under the Arizona Uniform Fraudulent Transfer Act (Arizona UFTA) and IRC § 6901.
In July 2018, reversing the Tax Court for the second time, the Ninth Circuit held that the petitioners were liable for the transferor corporation’s tax obligations. The IRS has calculated these numbers to include a deficiency of $13.5m, an accuracy-related penalty of $2.7m, and interest of $8.6m, for a total of $24.8m. The Ninth Circuit remanded the cases “for entry of judgment in favor of the Commissioner.” The Tax Court, begrudgingly albeit “accordingly” directed decisions to be entered under Tax Court Rule 155.
The parties have submitted dueling Rule 155 computations. They agree that the transferor corporation’s total tax liability is $24.8m. However, they disagree as to the extent to which the petitioners are liable for this debt. The petitioners contend that they are not liable for the penalty or “pre-notice” interest, that the IRS has “double counted” the transfers, and that they are entitled to reductions for “equitable recoupment.”
Finding no merit in the arguments that the petitioners tendered in support of their computations, the Tax Court entered decisions as requested by the IRS…proving that sometimes knuckling under is the easiest way to get rid of a bully.
Factual Background to Slone v. Commissioner
These cases grow out of a stock-sale transaction commonly known as an “intermediary company” or “Midco” transaction. Midco transactions, a type of tax shelter, were widely promoted during the late 1990s and early 2000s. Fortrend International, LLC, which engineered the deal here, was a leading promoter of Midco transactions. It has been involved in numerous cases previously considered by the Tax Court. In Notice 2001-16, clarified by Notice 2008-111, the IRS listed Midco transactions as “reportable transactions” for Federal income tax purposes.
Promoters of Midco transactions offered a purported solution to this problem. An “intermediary company” affiliated with the promoter—typically a shell company, often organized offshore—would buy the shares of the target company. The target’s cash would transit through the Midco to the selling shareholders. After acquiring the target’s embedded tax liability, the Midco would engage in a sham transaction purporting to offset the target’s realized gains and eliminate the corporate-level tax.
The promoter and the target’s shareholders would agree to split the dollar value of the corporate tax thus avoided. The promoter would keep as its fee a negotiated percentage of the avoided corporate tax. The target’s shareholders would keep the balance of the avoided corporate tax as a premium above the target’s true net asset value (i.e., assets net of accrued tax liability).
In due course the IRS would audit the Midco, disallow the fictional losses, and assess the corporate-level tax. But the Midco, having distributed its cash to the selling shareholders, would typically be asset-less and judgment-proof. The IRS would then be forced “to seek payment from other parties involved in the transaction in order to satisfy the tax liability the transaction was created to avoid.”
In 2001 Fortrend engineered a Midco transaction for the petitioners. Slone Broadcasting sold its assets to another broadcasting company for $45 million, generating a taxable gain of $38,598,926 and a combined Federal and state tax liability of about $15,314,000.
The trusts then agreed to sell their Slone Broadcasting stock to a Fortrend affiliate (Berlinetta). At that point, Slone Broadcasting had a net asset value (taking account of its accrued tax liability) of less than $27 million. But Berlinetta agreed to pay the trusts for their stock roughly $29.8 million, plus assumption of all Federal and state tax liabilities. Having no appreciable assets, Berlinetta for this purpose borrowed $30 million from Rabobank, a Dutch bank that facilitated many Midco transactions.
On December 12, 2001, two days after the stock sale closed, Slone Broadcasting merged with Berlinetta and changed its name to Arizona Media Holdings (AMH). AMH used the proceeds of the asset sale to pay off Berlinetta’s loan from Rabobank, leaving AMH a shell company with a large tax liability and essentially no assets. AMH engaged in a sham transaction that purported to eliminate its tax liability. In July 2002 AMH filed a Form 1120, U.S. Corporation Income Tax Return, reporting a $37.9m gain from the asset sale and a loss of $38m from the sham transaction.
In May 2008 the IRS assessed that liability plus accrued interest. Having no meaningful assets, AMH made no payments toward this debt. In August 2009 AMH was dissolved by the Arizona secretary of state for failure to file its annual report.
The Initial Tax Court Decision in Slone v. Commissioner and the Ninth Circuit Doing What it Does Best (Picking Dandelions in FAR Left Field)
Unable to collect the tax from AMH, the IRS initiated a transferee liability examination of the petitioners. On December 22, 2009, the IRS issued Letters 902–T, Notice of Liability, to the Slone Trust and the GST Trust, determining that they were liable, as transferees of Slone Broadcasting, for $16.2m and $2.6m , respectively, plus accrued interest. The IRS issued separate notices of liability to Mr. and Mrs. Slone, as transferees of the transferees, determining that each was liable for $16.2m, plus accrued interest. The petitioners timely petitioned this Court, all residing in Arizona at that time.
Following the initial remand from the Ninth Circuit, the Tax Court examined the Arizona UFTA to determine whether the petitioners were liable as transferees. The petitioners contended that the form of the transaction—i.e., a stock sale by the Trusts to Berlinetta—should be respected. The IRS, with haughty indignation, contended that the form of the transaction should be disregarded and that it should be treated as a liquidating distribution from Slone Broadcasting for purposes of applying the UFTA.
The Tax Court ruled that the petitioners were not liable as transferees on the theory that the petitioners and their advisers did not have actual or constructive knowledge of Fortrend’s tax strategies for evading payment of Slone Broadcasting’s tax debt. The Ninth Circuit again reversed, concluding that the petitioners were “at the very least” on constructive notice that the entire scheme had no purpose other than tax avoidance.
The Ninth Circuit accordingly held that the transfer to the petitioners was a “constructively fraudulent transfer” under the Arizona UFTA, and the petitioners were thus liable as “transferees” IRC § 6901. The Ninth Circuit once again remanded the cases for entry of judgment in favor of the IRS.
Transferee Liability – Basis in Code
IRC § 6901 permits the IRS to assess a tax liability against a person who is “the transferee of assets of a taxpayer who owes income tax.” To impose this liability, a court must determine whether “the party [is] substantively liable for the transferor’s unpaid taxes under state law” and whether that party is a “transferee” within the meaning of IRC § 6901. The Ninth Circuit resolved both of these questions in the IRS’s favor, insofar as the hippies held that the transfers to the petitioners were “constructively fraudulent transfers” under the Arizona UFTA and that the petitioners were liable to the government for Slone Broadcasting’s federal tax obligation as “transferees” under IRC § 6901.
Because the petitioners are “transferees” under IRC § 6901, they are liable for Slone Broadcasting’s tax liability “up to the limit of the amount transferred” to them. The parties agree that Slone Broadcasting’s unpaid liability includes (among other things) a deficiency of $13.5m. Mr. and Mrs. Slone each received $13, and the GST Trust received $2.6m. Because the deficiency by itself exceeds each of these amounts, the IRS’s recovery against these three transferees is capped at the value of the assets that each received.
However, the Slone Trust received $30.8m, an amount that exceeds Slone Broadcasting’s total liability of $24.8m. The IRS thus contends that the Slone Trust is liable for the transferor’s entire liability, including the deficiency, the accuracy-related penalty of $2.7m, and pre-notice interest of $8.6m. “Pre-notice interest” consists of interest that accrued on the deficiency and penalty under IRC § 6601(a) between the due date of AMH’s 2001 tax return and the date on which the notices of liability were mailed to the petitioners.
The Petitioners’ Contentions in Slone v. Commissioner (that Held no Water)
The petitioners contend that the Slone Trust is liable only for the deficiency and post-notice interest, i.e., interest that accrued after the notices of liability were mailed to the petitioners. They assert that the IRS is improperly “double counting” the transfers, seeking to recover an aggregate amount in excess of Slone Broadcasting’s tax liability. And they contend that they are entitled to reductions for “equitable recoupment.” The Tax Court addressed these arguments in turn…and not so favorably for the petitioners.
Further, the petitioners argued that the IRS was foreclosed from recovering any portion of the penalty because claims for penalties against the transferor…did not come into existence until long after the transfers at issue. For this proposition they rely on Stanko v. Commissioner.
In Stanko the Eighth Circuit interpreted Nebraska law in effect before 1989, when Nebraska adopted the UFTA. The court reasoned that the penalties for negligent or intentional misconduct by the transferor that occurred many months after the transfer are not existing at the time of the transfer. The Eighth Circuit concluded that a creditor whose debt did not exist at the date of the transfer cannot have the conveyance declared fraudulent unless he pleads and proves that the conveyance was made to defraud subsequent creditors whose debts were in contemplation at the time.
In Tricarichi v. Commissioner (Tricarichi I), the Tax Court held that the Eighth Circuit’s reasoning in Stanko does not apply to cases where liability under state law is determined (as it is here) under the UFTA. In Tricarichi I, such question was governed by Ohio’s UFTA, which differed from the pre-UFTA Nebraska statute that the Eighth Circuit was construing. As the Tax Court explained, the Ohio UFTA defined “claim” expansively to include any “right to payment” even if it is “unliquidated” and “unmatured.”
The IRS may thus have a “claim” for the penalties whether or not they are thought to have been “existing at the time of the transfer.” The Tax Court noted that it had “reached the same conclusion concerning transferee liability for penalties under the fraudulent transfer laws of other States.” The Ninth Circuit, to which appeal of the instant cases would lie, affirmed the Tax Court’s holding.
The Tax Court’s analysis in Tricarichi fully applies here. Like the Ohio UFTA, the Arizona UFTA defines “claim” as “a right to payment, whether or not the right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured or unsecured.” The Supreme Court of Arizona has described this definition as “unquestionably broadly worded,” ruling that it includes “unknown and unasserted claims.” Thus, the Arizona UFTA supports transferee liability even if the penalty were thought to be an “unknown and unasserted claim” when the Slone Trust received the transfer.
The Arizona UFTA, moreover, does not require proof that a transfer was made to defraud a specific existing creditor (such as the IRS). Even if the IRS’s penalty claim were regarded as not being “in existence” on the date of the transfer, the Slone Trust would have transferee liability under Ariz. Rev. Stat. Ann. § 44-1004(A)(2) (the Arizona UFTA).
Under that provision, liability to future (as well as present) creditors exists if the transfer was made without the debtor’s receiving “a reasonably equivalent value in exchange” and the debtor intended to incur, or it believed or reasonably should have believed that he would incur, debts beyond his ability to pay as they became due. For these reasons, the Tax Court rejected the petitioners’ argument that their transferee liability excludes the accuracy-related penalty.
Finally, the petitioners assert that they have no transferee liability for the penalty because the IRS failed to meet its burden of production, which (they say) includes showing timely supervisory approval under IRC § 6751(b)(1). This argument fails for at least two reasons. First, the petitioners did not advance this argument at any point during the trial or appellate proceedings. Quite the contrary: AMH executed a Form 870–AD conceding liability for an accuracy-related penalty of $2.7m. The petitioners’ IRC § 6751(b) argument is thus a “new issue” that “may not be raised in the context of a Rule 155 computation.”
Second, IRC § 7491(c), which imposes a burden of production on the IRS in certain circumstances, applies only in cases involving “the liability of any individual for any penalty.” These cases involve the tax liability of Slone Broadcasting, a corporation. Although Mr. and Mrs. Slone are individuals, the IRS has not determined any distinct penalties against them, but rather has determined that they bear transferee liability for Slone Broadcasting’s corporate tax debt.
Editor’s Note: This is, perhaps, a bit of a stretch for the Tax Court, but again, Judge Lauber seems pretty damn sick of getting reversed and remanded, so this may be a factor in this potential overreach.
Liability for Pre-Notice Interest
The petitioners next argued that they had no liability for pre-notice interest, i.e., interest that accrued on the corporate tax liability through December 2009 (when the IRS issued the notices of liability). The petitioners contended that any pre-notice interest “is not recoverable against the transferees under Arizona state law.” Unfortunately for the petitioners, the Tax Court had addressed and had summarily rejected substantially the same argument in Tricarichi II.
As it explained in Tricarichi II, the Tax Court found that the law on this subject had been elaborated in a long line of cases dating back many decades. Where “the value of the assets distributed to the transferee substantially exceed[s] the transferor’s aggregate liability for deficiencies, penalties, and interest, the transferee’s liability for interest is governed by, and must be computed in accordance with, the Internal Revenue Code.”
On the other hand, however, if the transferred assets are insufficient to satisfy the IRS’s claim against the transferor, the IRS may have a further right to collect pre-notice interest from the transferee, based on the transferee’s wrongful use of the transferred assets. This latter right is one that is founded on State law, and the Tax Court held that it is only in such circumstances that it becomes appropriate to investigate State law to determine the IRS’s right to interest.
Thus, in Tricarichi II, the Tax Court held that the IRS was entitled to recover pre-notice interest from the transferee, at the rate specified in IRC § 6621, because the transferee received assets with a value in excess of the transferor’s total Federal tax liability (including pre-notice interest).
On appeal the Ninth Circuit affirmed that holding. Phew. The Hippie Circuit ruled that, where the transferee receives assets with a value exceeding the transferor’s liability, the Code determines pre-notice interest, and the availability of interest under state law is irrelevant.
So, the Ninth Circuit affirmed, but on totally different grounds. But, a win is a win, the Tax Court supposed…
On this point the salient facts of these cases are the same as in Tricarichi II. The Slone Trust received cash totaling $30.8m, but Slone Broadcasting’s aggregate Federal tax liability was only $24.8m. Because the Slone Trust received assets with a value that exceeded the transferor’s total tax liability (including pre-notice interest), the Slone Trust’s liability for interest is governed by Federal law, and the availability of interest under Arizona law is irrelevant. The Tax Court thus held that the IRS was entitled to recover pre-notice interest as provided in IRC § 6601(a) and IRC § 6621.
Alleged “Double Counting”
“Transferee liability is several” under IRC § 6901. The petitioners are thus severally liable for Slone Broadcasting’s tax debt (up to the value of the assets that each received). Indeed, the fact that more than one person is responsible for a particular delinquency does not relieve another responsible person of her personal liability, nor can a responsible person avoid collection against herself on the ground that the Government should first collect the tax from someone else.
Of course, “the tax liability of the transferor can be collected only once.” Thus, the IRS may take no further collection action against any of the transferees once Slone Broadcasting’s aggregate tax liability of $24.8m (plus post-notice interest) has been satisfied in full. But the petitioners cannot reduce or eliminate the Slone Trust’s liability for pre-notice interest and the accuracy-related penalty by insisting that the IRS must seek recovery from Mr. and Mrs. Slone instead.
Finally, the petitioners urge that they are entitled to reduction of their transferee liability under the doctrine of “equitable recoupment.” This entitlement, they contend, arises as a consequence of the Ninth Circuit’s recharacterization of their stock-sale transaction as a liquidating distribution from Slone Broadcasting. Importantly, the Tax Court observed that
Although the petitioners may have a valid point, their claim for equitable recoupment is not yet ripe.
Equitable recoupment is an equitable remedy designed to prevent injustice where the Government has taxed a single transaction, item, or taxable event under two inconsistent theories. The IRS does not dispute that this Court has jurisdiction to apply the doctrine. But the “basic requirement for equitable relief has always been the inadequacy of the remedy at law.” IRC § 1341, however, “appears to provide a legal remedy for the problem that the petitioners have identified.”
IRC § 1341 is captioned “Computation of Tax Where Taxpayer Restores Substantial Amount Held Under Claim of Right,” and it applies where
- an item was included in gross income for a prior taxable year because it appeared that the taxpayer had an unrestricted right to such item; and
- a deduction is allowable in a later year because it was established after the close of such prior taxable year that the taxpayer did not have an unrestricted right to such item or to a portion of such item.”
If these conditions are met, and if the deduction exceeds $3,000, the taxpayer’s tax for the later year is reduced by taking account of this deduction.
The Tax Court has repeatedly held that the remedy of equitable recoupment is not available when IRC § 1341 provides an adequate remedy at law:
Where a taxpayer has in one year received an amount from a corporation under a claim of right and paid a tax upon the receipt, he is not entitled to recover the tax paid in the prior year under a doctrine of equitable recoupment when it is later determined that he is liable as transferee for tax of the corporation making the distribution to him.
IRC § 1341 thus “provides the appropriate remedy” where a transferee is “required to restore payments which he had received under a claim of right.” A transferee must therefore pursue a claim under IRC § 1341 before seeking equitable recoupment.
The petitioners, however, do not now have an existing claim under IRC § 1341. That section applies only if “a deduction is allowable” for the later year. The petitioners are cash basis taxpayers, and no deduction will be allowable on account of their transferee liability until they have paid the tax. The Tax Court accordingly concluded that neither the doctrine of equitable recoupment nor the petitioners’ IRC § 1341 claim is properly before us in these cases.
HOWEVER – and it’s a big however…
After paying the tax, the petitioners in Slone v. Commissioner may pursue these forms of relief by filing claims for refund and (if their claims are denied) by commencing suit in district court or the U.S. Court of Federal Claims.
Take that, you smelly Hippies.
(T.C. Memo. 2022-6) Slone v. Commissioner
- Slone III, T.C. Memo. 2016-115. ↑
- Slone IV, 896 F.3d 1083, 1088 (2018). ↑
- See IRC § 6901(a). ↑
- See IRC § 6901(c)(2). ↑
- See Slone III. ↑
- Slone IV, 896 F.3d at 1085. ↑
- Id. at 1088. ↑
- Salus Mundi Foundation v. Commissioner, 776 F.3d 1010, 1017 (9th Cir. 2014). ↑
- Slone II, 810 F.3d at 604 (quoting Salus Mundi Found., 776 F.3d at 1018). ↑
- Slone IV, 896 F.3d at 1088. ↑
- See Schussel v. Werfel, 758 F.3d 82, 93 (1st Cir. 2014), aff’g in part, rev’g in part, and remanding T.C. Memo. 2013-22. ↑
- 209 F.3d 1082 (8th Cir. 2000), rev’g T.C. Memo. 1996-530. ↑
- See id. at 1084 n.1. ↑
- Id. at 1088. ↑
- Id. at 1087 (quoting U.S. Nat’l Bank of Omaha v. Rupe, 296 N.W.2d 474, 476 (Neb. 1980)). ↑
- T.C. Memo. 2015-201. ↑
- Id. ↑
- Id. (quoting Ohio Rev. Code Ann. § 1336.01(C)). ↑
- Id. (quoting Stanko, 209 F.3d at 1088). ↑
- Id. ↑
- Tricarichi v. Commissioner (Tricarichi III), 752 F. App’x 455 (9th Cir. 2018). ↑
- Ariz. Rev. Stat. Ann. § 44-1001.2 (2021). ↑
- Hullett v. Cousin, 63 P.3d 1029, 1034 (Ariz. 2003). ↑
- Ariz. Rev. Stat. Ann. § 44-1004(A)(2)(b); see Slone IV, 896 F.3d at 1086-87 (finding the petitioners liable under Ariz. Rev. Stat. Ann. § 44-1004(A)(2)); cf. Tricarichi I, T.C. Memo. 2015-201 (holding to same effect under Ohio UFTA). ↑
- Shade included in original. ↑
- Vento, 152 T.C. 1, 8 (2019). ↑
- See Dynamo Holdings Ltd. P’ship v. Commissioner, 150 T.C. 224, 230 (2018) (observing that the IRS “does not bear the burden of production with respect to penalties in a corporate or partnership-level proceeding”). ↑
- T.C. Memo. 2016-132, slip op. at *7. ↑
- Id. (citing Cappellini v. Commissioner, 16 B.T.A. 802 (1929)). ↑
- Id. (citing Lowy v. Commissioner, 35 T.C. 393, 397 (1960)). ↑
- Id. ↑
- Id. at 36. ↑
- Tricarichi IV, 908 F.3d at 593. ↑
- Alexander v. Commissioner, 61 T.C. 278, 295 (1973); Tricarichi I, T.C. Memo. 2015-201. ↑
- Woodley v. Commissioner, T.C. Memo. 2017-242 (quoting USLIFE Title Ins. Co. of Dallas v. Harbison, 784 F.2d 1238, 1243 (5th Cir. 1986)) (discussing joint and several liability under IRC § 6672). ↑
- Holmes v. Commissioner, 47 T.C. 622, 627 (1967). ↑
- See Morris v. Commissioner, T.C. Memo. 2000-381. ↑
- United States v. Dalm, 494 U.S. 596, 605 n.5 (1990). ↑
- See IRC § 6214(b). ↑
- Estate of Stein v. Commissioner, 37 T.C. 945, 956-57 (1962). ↑
- IRC § 1341(a)(1) and (2). ↑
- See IRC § 1341(a)(3), (4), and (5). ↑
- Maynard Hosp., Inc. v. Commissioner, 54 T.C. 1675, 1676 (1970); see Estate of Stein, 37 T.C. 945, 958 (1962) (holding that equitable recoupment is unavailable in cases to which IRC § 1341 applies); Delpit v. Commissioner, T.C. Memo. 1992-297 (same), supplementing T.C. Memo. 1994-147. ↑
- Maynard Hosp., Inc., 54 T.C. at 1676; see Estate of Stein, 37 T.C. at 957 (ruling that IRC § 1341 provides “a remedy superior to and inclusive of equitable recoupment”); Kardash v. Commissioner, T.C. Memo. 2015-197 (same), supplementing T.C. Memo. 2015-51. ↑
- IRC § 1341(a)(2). ↑
- See Estate of Stein, 37 T.C. at 957 (stating that relief is available “in the year of repayment”). ↑
- See 28 U.S.C. § 1346(a) (District Court), see 28 U.S.C. § 1491(a) (Court of Federal Claims). ↑
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