As a tax controversy lawyer, most of your clients come to you in quite a predicament with the IRS, rather than coming to you to avoid said predicament. Such is the case when Cousin Elmer comes to visit you one dismal winter day. You may remember Elmer from our article on FBARs, but if not, Cousin Elmer has seven and a half fingers from trying, rather unsuccessfully, to eradicate his attic’s squirrel population through the use of what can only be described as an Vietnam-era improvised explosive device (IED).
It turns out that Elmer took some of his foreign inheritance and bought the assets of a 50-year-old diner in Biddeford, which had been condemned a year ago, but which remained open due to the mayor’s bi-weekly buckwheat pancake habit. When the roof of the diner finally collapsed after a particularly brisk snowstorm, the owner—an old man named Ray—who had been just a boy when the original roof had collapsed, decided to get out of the diner business.
Elmer who had been a regular denizen of the restaurant offered to buy the flattop, the fryer, the walk-in, and the rather Rubenesque waitresses who worked there. Elmer paid cash, and the owner handed over the keys, spatulas, and nametags. There were multiple reasons that Elmer bought the diner, each of whom were the aforementioned waitresses that Elmer had taken quite a shining to. Elmer had grandiose plans about the diner he would build, and he sunk a chunk of change into creating his magnum opus, The Maine Diner. His play on words brought him more pleasure than any success as a restauranteur could ever have.
As Uncle Bill’s side of the family is wont to do, Elmer came to your office in a whirlwind of a tizzy. It turns out, none of the waitresses, technically, ever paid employment taxes. Ray, the previous owner, likewise failed to withhold employment taxes and pay them over to the IRS. As a consequence, a $250,000 tax lien was filed against the diner. Earlier that day, Elmer received a notice of intent to levy on his own bank accounts. He wants to know why on God’s green earth is he being punished for Ray’s tax misdeeds.
You sit Elmer down on the couch in your office (that is most certainly not for napping), and you get him a glass of water with a half of a Xanax crushed up inside. You then begin to explain the doctrines of transferee and successor corporate liability. His eyes become a bit glazed, and you are not sure whether it is the taxish you are speaking or the drugs kicking in. Nonetheless, you continue.
Transferee Liability in General
The IRS may collect an unpaid liability from the assets of a corporation transferred by the seller to the buyer, if the corporation has unpaid taxes in the years prior to the sale. This type of liability is known as “successor liability” or “transferee liability.” If the IRS invokes transferee liability, it may do so by filing a suit under state law or under the deficiency procedures of IRC § 6901.
In most cases, the IRS chooses the deficiency route and follows the notice of deficiency procedures applicable to income tax deficiencies set forth in IRC § 6901(a). Once the IRS determines that a corporation is a successor in interest to the previous corporation that had unpaid tax liabilities, it may send the successor company in notice of deficiency or a notice of transferee liability. As with any notice of deficiency proceeding, the taxpayer has 90 days to petition the Tax Court for relief.
IRC § 6901 does not impose liability on the transferee but merely gives the IRS a procedure to collect the transferor’s existing liability.[1] The IRS may collect the transferor’s unpaid tax from the transferee if an independent basis exists under applicable state law or state equity principles for holding the transferee liable for the transferor’s debts.[2] State law determines the elements of liability, and IRC § 6901 provides the remedy or procedure to be employed by the IRS as the means of enforcing that liability.[3] The applicable state law is the law of the State where the transfer occurred.[4]
Finally, IRC § 6901 allows the IRS to collect a taxpayers’ unpaid tax from another person if three conditions are met. First, the taxpayer must be liable for the unpaid tax. Second, the other person must be a “transferee” within the meaning of IRC § 6901. Third, an independent basis must exist under applicable state law or state equity principles for holding the other person liable for the taxpayer’s unpaid tax.[5] IRC § 6901 does not apply if one or more of these three conditions is not met.[6]
Who is a Transferee?
Under IRC § 6901(h), the term “transferee” includes a donee, heir, legatee, devisee, and distributee, and with respect to estate taxes, also includes any person who, under IRC § 6324(a)(2) (liens for estate and gift taxes) is personally liable for any part of such tax. Under IRC § 6901(a)(1)-(2), the term transferees applies first, to individuals who receive property from a taxpayer’s estate, including a fiduciary; second, to stockholders who receive stock or assets of a dissolved corporation; third, to individuals who receive property from an insolvent taxpayer whether through a gift, a will, or other distribution; fourth, to the successor of a corporation that was wholly liquidated or was subject to a reorganization within the meaning of IRC § 368(a); and fifth, all other classes of distributees.[7]
IRC § 368 deals with particular types of mergers, acquisitions, recapitalizations, changes in identity, and transfers of assets or stock. A transfer by a corporation of all or part of its assets to another corporation will be treated as an IRC § 368 reorganization if immediately after the transfer the transferor (or its shareholders) is in control of the corporation to which the assets are transferred. In the present case Elmer bought all of Ray’s Diner’s assets, but Ray had no ownership interest in The Maine Diner. As such, IRC § 368 does not apply. It is also important to note, IRC § 6901 is strictly a procedural statute, and it does not impose substantive liability on a transferee; applicable Federal and State law determines the transferee’s liability.[8]
What is Considered a Transfer for Purposes of Transferee Liability
When cousin Elmer hands you a five-dollar bill, that is a direct transfer. With regard to transferee liability, the transfer can be direct or indirect. Direct transfers include (a) the disposition of or parting with an asset or an interest in an asset; (b) the payment of money or the payment of debt; (c) the granting of a lease; and (d) the compensation, especially when excessive, paid to corporate officers. Examples of indirect transfers include (a) the release of a debt or claim; (b) the creation of a lien or other encumbrance; (c) the distribution of sale proceeds or other corporate assets to shareholders; and (d) a sham transaction.
What Types of Transferee Liability Exist?
The IRS may seek to collect a taxpayer’s unpaid tax, penalty, or interest through pursuit of one of the transferee theories. Transferee liability under the law may arise under a contract, under federal statutes, or under state law. A representative of a person or an estate[9] paying any part of a debt of the person or estate before paying a debt due to the United States is personally liable to the extent of the payment for unpaid claims of the United States. However, a fiduciary is not liable unless the fiduciary knows of the debt or had information that would put the fiduciary on notice that an obligation was owed to the United States.
Under the successor liability theory, the IRS seeks to impose liability because the transferor/taxpayer sold or transferred assets to, or merged with, another corporation and the recipient or surviving corporation is liable under state law for the debts of the predecessor corporation. A successor liability is dependent on state law. Under certain circumstances, a successor in interest named on a Special Condition NFTL is entitled to Collection Due Process rights.[10] It appears that this is the IRS’s theory in Elmer’s case, though you would have to brush up on Maine mergers and acquisitions law to be sure that the IRS was correct in proceeding under this theory.
The nominee theory allows collection from specified property held in the name of the taxpayer’s nominee. This theory is based on the premise that a third party holds specific assets for the taxpayer; and at the same time the taxpayer retains benefit, use, or control over the specific assets. A transfer is not a requirement of this theory. Thus, the nominee theory focuses on the relationship between the taxpayer and the property. Similarly, the alter ego theory allows collection from all the property of a taxpayer’s alter ego. This theory is based on the premise that the taxpayer and the alter ego are so intermixed that their affairs are not readily separable. Thus, the alter ego theory focuses on the relationship between the taxpayer and the alter ego.
Establishing Transferee Liability
The transferee is liable for tax either at law or in equity.[11] Liability at law arises out of a part of a contract (either an express or implied agreement), or out of a federal or state law. Additional proof is needed to establish that an individual is a transferee at law. The IRS must show that the transferor transferred property to the transferee, and the transferor remains liable for the tax. Next, the IRS must prove both that the transferor was liable for the tax at the time of the transfer, or transfer occurred in the year of liability; and that the transferor and transferee entered into a contract in which the transferee expressly or impliedly agreed to assume the transferor’s tax liability, or liability is directly imposed on the transferee (strict liability) under a federal or state statute or case law.[12]
Transferee liability in equity is based on fraudulent conveyance laws that were initially developed by courts based on the principle that debtors may not transfer assets for less than adequate consideration if they are left unable to pay their liabilities.[13] Although the doctrine was initially based on the common law (case law), both federal and state statutes now address setting aside transfers based on a fraudulent conveyance. To prove transferee liability in equity, the IRS must prove that all reasonable efforts have been made to collect the liability from the transferor/taxpayer, and first, the transferor was liable for the tax at the time of the transfer, or the transfer occurred in the year of liability; second, the value of the transferred property at the time of transfer, and that the transfer was for less than adequate consideration; and third, the transferor was insolvent, or the transfer made the transferor insolvent.[14]
The “Trust Fund Doctrine”
The trust fund doctrine is a judicially created equitable doctrine.[15] The theory behind the doctrine is that when a transfer leaves the transferor without enough assets to pay debts, the transferee holds the transferred property “in trust” for the benefit of the transferor’s creditors.[16] Because the trust fund doctrine is equitable in nature, it arises under state law or case law, and, therefore, state law must be consulted to determine the specific requirements.
The trust fund doctrine is most commonly used to impose transferee liability on a shareholder for taxes incurred by a corporation when the shareholder receives assets from a corporation prior to its dissolution.[17] Recovery under the doctrine is limited to the value of the property transferred. Many states have also enacted statutes to permit creditors of a corporation to sue shareholders.[18]
Burden of Proof
In proceedings before the Tax Court the burden of proof is on the IRS to show that the taxpayer is liable as a transferee of property of a transferor/taxpayer, but not to show that the transferor/taxpayer was liable for the tax.[19] A transferor’s deficiency is presumed correct, but a transferee may prove otherwise. The transferee, not the IRS, has the burden of proof on this issue.[20] The transferee may not relitigate a transferor’s tax liability when a court has already decided the issue.[21] In a proceeding before the United States Tax Court under IRC § 6901, the burden is on the IRS to prove that a transferee is liable for the tax of the transferor taxpayer.[22]
Statute of Limitations for Assessment of Transferee Liability
With regard to cases of transferee liability, IRC § 6901(c) states that the period of limitations for the assessment of any liability of a transferee will be one year after the expiration of the period of limitation for assessment against the transferor. The statute of limitations for a fiduciary is also generally one year, but it may be longer depending on the expiration of the period for collection of the tax in respect of which the liability arose.
Successor Liability of a Corporation as a Transferee
Successor liability for a transferee may arise under two different scenarios. First, a corporation surviving or resulting from a merger, consolidation, or reorganization of one or more corporations; or second a corporation to which all or substantially all of the assets of another corporation has been sold or otherwise transferred.[23] State law governing successor liability generally imposes liability in the following circumstances: (a) when the successor expressly or impliedly assumes the liabilities; (b) when a corporation reorganizes, merges or consolidates with another corporation; (c) when one corporation transfers its assets to another corporation but the corporations do not formally merge, there may nevertheless be a de facto merger or the successor may be considered a mere continuation of the corporation selling or transferring assets; or (d) the transaction amounts to a fraudulent conveyance.[24] In these instances, the IRS may rely on successor liability doctrine to hold a successor corporation liable for the tax debts of its predecessor. Once again, successor liability is equitable in nature and is controlled by state laws.
When determining whether a de facto merger or mere continuation exists, courts may look at whether (a) the second corporation continues the business or performs the same functions of the taxpayer; (b) the taxpayer’s employees become the employees of the second corporation; (c) the taxpayer and the second corporation are owned or controlled by the same individual or individuals; (d) the successor’s business activities are carried out in the same location; (e) less than full consideration is paid for the transferred assets; and (f) the business relationships remain relatively static.[25] If the surviving corporation may be held liable for the transferor’s debts as a successor under either a statute imposing liability or case law, the transferor’s tax liability may be collected from the successor using the IRC 6901 procedures.[26]
Extent of Transferee Liability
The amount of the transferee’s liability for the transferor’s unpaid tax, penalties, and interest depends on whether transferee liability is based in equity or at law. When transferee liability is based in equity, the transferee’s liability is generally limited to the value of the property transferred.[27]
Generally, transferee liability at law is full liability, regardless of the value of the assets received, unless limited by state or federal law or by agreement.[28] Where transferee liability is based on state law, state law determines the extent of liability.[29] Liability is not limited to the value of the assets transferred if there is a reorganization, merger, consolidation, or the successor corporation is the result of a de facto merger or a mere continuation of the taxpayer.[30]
Each transferee is jointly and severally liable for the transferor’s unpaid taxes to the extent of the value of assets received at the time of transfer. The IRS therefore is not required to apportion liability among transferees.[31]
Assessing Liability under IRC § 6901
The IRS may administratively impose liability for the transferor’s tax liability on a transferee or fiduciary. The liability may then be collected from any of the transferee’s or fiduciary’s property. This approach is generally preferable when the value of the property has decreased since the transfer. To hold a transferee or fiduciary liable for another’s tax, the IRS mails a notice of transferee or fiduciary liability to the transferee or fiduciary’s last known address. Then if a Tax Court petition is not filed or if the liability is sustained by the Tax Court, the IRS can assess the tax against the transferee under the authority of IRC § 6901.
IRC § 6901 provides a procedure by which the IRS may assess and collect the unpaid taxes, penalties, and interest from a transferee or from a fiduciary. The procedures for establishing transferee and fiduciary liability under IRC 6901 are similar to the deficiency procedures. A notice of transferee or fiduciary liability must be mailed to the last known address of the transferee or fiduciary. The transferee or fiduciary may petition the Tax Court within 90 days.
Collecting from the Transferee
The IRS may bring an action in district court against a transferee or fiduciary to impose transferee or fiduciary liability,[32] or a suit to set aside a fraudulent conveyance.[33] The IRS may invoke the procedures under IRC § 6901, which provides a mechanism for collecting the unpaid taxes, penalties, and interest from a transferee or fiduciary when a separate substantive legal basis provides for the transferee’s or fiduciary’s liability. An assessment under IRC § 6901 allows for collection against any assets held by the transferee or fiduciary.[34]
Conclusion
When you turn back around from the whiteboard next to your desk, you find Elmer is snoozing comfortably on the couch. You wipe down the whiteboard, put away the visual aids, and sort through your index cards to ensure you didn’t miss anything. Elmer’s snoring begins to rattle the panes of glass that separate you from the hallway, and no less than four separate people stop in their tracks to determine why precisely you were running an Evinrude motor in your office. That kind of shenanigans is better left to the personal injury attorneys.
You put on your noise cancelling headphones, which are a blessing and a curse. On the one hand, they block out the associate in the office behind your desk who gesticulates loudly and often during his conversations with his girlfriend, Tammy, and clients alike. On the other, you have missed a few phone calls from other attorneys in your firm, and your excuse “I must have just stepped out when you called” is beginning to fall on deaf ears.
Elmer stirs and mutters “successor in interest,” and you smile that at least some of your talk went heeded. Perhaps he subconsciously absorbed the complexity of the transferee liability schema. Then, you look at the nubs of his fingers, and you think “Nope. Not likely.”
Footnotes:
[1] Commissioner v. Stern, 357 U.S. 39, 42 (1958).
[2] See IRC § 6901(a); Stern, 357 U.S. at 45; Hagaman v. Commissioner, 100 T.C. 180, 183 (1993); Starnes v. Commissioner, T.C. Memo.2011–63, slip op. at 15; Julia R. Swords Tr. v. Commissioner, 142 T.C. 317, 335-36 (2014).
[3] Ginsberg v. Commissioner, 305 F.2d 664, 667 (2d Cir.1962), aff’g 35 T.C. 1148 (1961); Starnes, T.C. Memo.2011–63, slip op. at 15; Swords, 142 T.C. at 336.
[4] See Stern, 357 U.S. at 45; Starnes, 680 F.3d at 426.
[5] Accord Diebold Found., Inc. v. Commissioner, 736 F.3d 172, 183-84 (2d Cir. 2013); Sawyer Trust of May 1992 v. Commissioner, 712 F.3d at 597, 604–05 (1st Cir. 2013).
[6] Accord Stern, 357 U.S. 39; Diebold Found., Inc., 736 F.3d at 183–184; Sawyer Trust of May 1992 v. Commissioner, 712 F.3d at 604–605; Starnes, 680 F.3d at 430.
[7] See Treas. Reg. § 301.6901-1(b).
[8] Stern, 357 U.S. at 42-44; see also IRM 5.17.14.5.1(2).
[9] Except a trustee acting under the Bankruptcy Code of Title 11.
[10] IRM 5.17.14.2.3(1) (citing IRM 5.12.7.6.4(3)).
[11] IRM 5.7.14.3.3(1).
[12] IRM 5.7.14.3.3(3).
[13] IRM 5.7.14.3.3(4).
[14] IRM 5.7.14.3.3(5).
[15] Application of the “trust fund doctrine” as used here should not be confused with the assertion of the “trust fund recovery penalty” under IRC 6672. IRC 6672 directly imposes liability on a third party – the person required to collect, truthfully account for, and pay over any tax imposed who willfully fails to do so.
[16] IRM 5.17.14.3.3.3(1).
[17] See, e.g., Benoit v. Commissioner, 238 F.2d 485, 491 (1st Cir. 1956).
[18] See IRM 5.17.14.2.3.5 (Transferee Liability of a Shareholder or Distributee of a Corporation).
[19] IRC § 6902(a); Rule 142(d); Alonso v. Commissioner, 78 T.C. 577, 580.
[20] IRC § 6902(a).
[21] Jahncke Serv., Inc. v. Commissioner, 20 BTA 837 (1930).
[22] IRC § 6902(a).
[23] IRM 5.17.14.3.3.4(1).
[24] IRM 5.17.14.3.3.4(3).
[25] IRM 5.17.14.3.3.4(4).
[26] IRM 5.17.14.3.3.4(5).
[27] Phillips-Jones Corporation v. Parmley, 302 U.S. 233, 237 (1937).
[28] Bos Lines, Inc. v. Commissioner, 354 F.2d 830, 837 (8th Cir.1965), aff’g T.C. Memo.1965-71 (holding that when transferee liability is “at law” because the transferee has agreed to assume the transferor’s liability, the transferee is liable for the full amount of the transferor’s liability, regardless of the value of the assets transferred).
[29] Stern, 37 U.S. at 44-45.
[30] See, e.g., Atlas Tool v. Commissioner, 70 T.C. 86, 113-14 (1978), aff’d, 614 F.2d 860 (3d Cir. 1980).
[31] IRM 5.17.14.3.4(4).
[32] See IRM 5.17.14.5.4 (Establishing Transferee or Fiduciary Liability by Suit).
[33] See IRM 5.17.14.5.6 (Suit to Set Aside a Fraudulent Transfer).
[34] See IRM 5.17.14.5.1 (Assessing Transferee and Fiduciary Liability).
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