When Does Interest Start Running on a Transferee Liability

We welcome back guest blogger Marilyn Ames. Marilyn is retired from Chief Counsel’s office but works with us on IRS Practice and Procedure assisting with many chapters because of the breadth of her knowledge. She has done a lot of writing on transferee liability and provides insight on a recent case in that area. Keith

When a taxpayer has an unpaid income tax liability, the Internal Revenue Code is clear that interest on the unpaid tax accrues from the original due date of the return. However, when the Internal Revenue Service attempts to collect liability under Internal Revenue Code § 6901, the transferee liability section, questions arise as to the ability of the IRS to collect interest on the unpaid tax debt.  Because Section 6901 is merely a procedural law, the Internal Revenue Service must look to state law or other federal law for the substantive provisions that allow collection of taxes from a person who receives property from the taxpayer. The Internal Revenue Code provides that a transferee is liable for interest on the unpaid tax debt after the Internal Revenue Service issues a notice of transferee liability, but does state law govern the collection of interest before this date? The Ninth Circuit addressed this in the recent case of Tricarichi v. Comm’r, 122 AFTR2d 2018-6634 (9th Cir. Nov. 13, 2018). 

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The transferee in this case, Michael Tricarichi, was the sole shareholder of West Side Cellular, Inc., which received a $65 million settlement in 2003. Before its return for 2003 was due, Mr. Tricarichi, who was then a resident of Ohio, sold his West Side stock in a “Midco” tax-shelter transaction, leaving West Side Cellular with insufficient assets to pay its corporate income taxes for 2003. Mr. Tricarichi received about $35.2 million in the transaction, and then moved to Nevada to enjoy the fruits of his labors. (The workings of the Midco transaction, which have been the subject of frequent litigation in the recent past, are outlined in Diebold Foundation, Inc. v. Comm’r, 736 F3d 172 (2d Cir. 2013)).

In 2012, the Internal Revenue Service issued a notice of transferee liability to Mr. Tricarichi, which was duly litigated in the Tax Court, the result being that the Tax Court determined that Mr. Tricarichi was liable for the full amount of West Side’s tax deficiency and the associated penalties and interest in the tidy total sum of about $35.1 million. In a separate opinion, the Ninth Circuit affirmed the Tax Court’s conclusion that Mr. Tricarchi was liable as a transferee under Internal Revenue Code § 6901 and the Ohio Uniform Fraudulent Transfer Act, leaving the question of when and whether a transferee is liable for the amount of interest due on the transferor’s tax liability before the notice of transferee liability is issued to this opinion.

Mr. Tricarichi, the transferee, argued that Ohio law determined his liability for any interest before the notice of transferee liability was interested. Under Ohio law, Mr. Tricarichi would have owed nothing instead of the nearly $13.9 million that accrued between the due date for the 2003 return and the issuance of the notice of transferee liability in 2012. He cited the Supreme Court’s decision in Commissioner v. Stern, 357 US 39 (1958), for the proposition that state law should determine the existence and extent of transferee liability, including the amount of the interest that can be collected on the underlying claim – which in Mr. Tricarichi’s view would be the tax and penalties owed by the taxpayer, but not the interest that accrued between the due date of the taxpayer’s 2003 return and June of 2012 when the IRS issued the notice of transferee liability.

The Ninth Circuit disagreed, holding that Internal Revenue Service’s claim is computed under the Internal Revenue Code, and will include statutory interest. The extent of the liability to be determined under state law is actually a question of the amount of the claim that can be recovered from the assets transferred. When the taxpayer transfers sufficient assets to pay the underlying claim, including the interest that has been accruing under the Internal Revenue Code for the unpaid tax liability, it is unnecessary to look to state law for the creation of a right to interest. It is only necessary to look to state law for interest when the assets transferred are insufficient to satisfy the total claim for the liability of the transferor/taxpayer. In that case, the relevant state law determines whether the Internal Revenue Service may recover any prejudgment interest beyond the value of the assets transferred. The Ninth Circuit adopted the “simple rule” formulated by the First Circuit in Schussel v. Werfel, 758 F3d 82 (1st Cir. 2014) that “the IRS may recover from [the transferee] all amounts [the transferor] owes to the IRS (including section 6601 interest accruing on [the transferor’s] tax debt), up to the limit of the amount transferred to [the transferee], with any recovery of prejudgment interest above the amount transferred to be determined in accord with [state] law.”

Under this relatively simple rule, because West Side’s tax deficiency, including interest and penalties was $35.1 million, and Mr. Tricarichi received $35.2 million in assets from West Side, an amount in excess of West Side’s tax liability, Mr. Tricarichi was liable for the full amount of the $35.1 million. The fact that Mr. Tricarichi will also be liable for interest as a transferee from the issuance of the notice of transferee liability in 2012 is irrelevant to the determination that he received more from West Side in assets than the tax claim against West Side. As a resident of Nevada, Mr. Tricarichi should understand that his attempt to break the bank in his litigation with the IRS has left him busted.

 

 

 

 

Are Alleged Alter Egos, Successors in Interest and/or Transferees Entitled to Their Own Collection Due Process Rights Under Sections 6320 and 6330? Part 4

Guest blogger Lavar Taylor continues his series on Collection Due Process and third parties. The series provides a deep dive into the jurisprudence of CDP cases and the rights of third parties to have an outlet to challenge the liens and levies made against these non-taxpayer parties held liable for the taxpayer’s obligations. Keith

This post looks at the question of how a putative alter ego, successor in interest or transferee of a taxpayer might pursue litigation in the Tax Court to raise the question of whether they are entitled to Collection Due Process (“CDP”) rights under §§6330 and 6320 of the Code, independent of the rights of the original taxpayer who incurred the liability. This discussion assumes, of course, that the IRS has the legal ability to pursue administrative collection action against a putative alter ego or successor in interest of the taxpayer, without first obtaining a judgment in District Court or without first making a separate assessment against the third party under section 6901.   As is explained in Part 3 of this series, such an assumption may not be correct.

This post also discusses how a putative alter ego/successor in interest/transferee might pursue litigation in the Tax Court to raise the issue discussed in Part 3, namely, whether the government can ever take administrative collection action against the putative alter ego/successor in interest/transferee in the absence of a District Court judgment holding that the putative alter ego/successor in interest/transferee is liable for some or all of the taxpayer’s tax liability.

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  1. Existing Tax Court Jurisprudence Regarding Tax Court Jurisdiction

The Tax Court has stated on numerous occasions that a notice of determination under the CDP provisions is a taxpayer’s “ticket” to the Tax Court in CDP cases, see Weber v. Commissioner, 122 T.C. 258, 263 (2004), and that a failure to file a timely petition in response to a notice of determination requires the Court to dismiss the petition for lack of jurisdiction. Id. The Tax Court has also held that, in a situation where the IRS issued a notice of intent to levy under §6330 and the taxpayer failed to request a CDP hearing, the Court lacked jurisdiction because no CDP hearing had been requested and no notice of determination had been issued by the IRS. Offiler v. Commissioner, 114 T.C. 492 (2000).

Thus, in situations where the IRS takes levy action, whether against a taxpayer or against a putative alter ego/successor in interest/transferee, without first issuing a CDP notice of intent to levy under §6330, and the party against which levy action files a petition with the Tax Court to challenge the validity of the levy action as having been taken in violation of §6330, the IRS will likely argue that the Tax Court lacks jurisdiction over the petition. Indeed, that is exactly what the IRS did in the case in which we filed petition with the Tax Court on behalf of our client, an alleged alter ego/successor in interest, after the IRS levied on our client’s bank accounts without providing any notice or other advanced warning whatsoever to our client.

The IRS can take this position even if the failure to issue a §6330 notice of intent to levy is in clear violation of the law. Of course, even if the IRS were to “concede” that the Tax Court has jurisdiction over a petition in this situation, such a “concession” would not be binding on the Tax Court. The Court has an independent duty to determine whether it has jurisdiction over a petition, regardless of the positions taken by the parties. SECC Corp. v. Commissioner, 142 T.C. 225 (2014).

The Tax Court has never held that it lacks jurisdiction over a petition in this precise situation, however. In one case where the Tax Court concluded that the IRS improperly levied on a taxpayer’s bank account without first issuing a Notice of Intent to Levy, the Court held that it had jurisdiction over the case because the IRS made a de facto “determination” for purposes of section 6330 in response to which a petition was filed and thus formed the basis of the Court’s jurisdiction. See Chocallo v. Commissioner, T.C. Memo 2004-152, 87 T.C.M. (CCH) 1432 (2004). In Chocallo, the Court also held that it had the ability to order the IRS to refund to the Petitioner all funds which Respondent had improperly seized or levied from the taxpayer.

[Curiously, it is not possible to access the docket sheet in the Chocallo case electronically. The Tax Court’s website indicates that the case is filed under seal. This seems to me to be very strange.   I have a distinct memory, from a number of years ago, of reading another Memorandum Decision, the name of which I cannot recall, which seemingly was issued either in the Chocallo case or in another case involving facts that were very similar to the facts in Chocallo, prior to the date of 2004 Chocallo opinon. Since I have not able to locate any other Memorandum Decision with similar facts, it would be nice if the seal in Chocallo were somehow lifted. I would then be able to figure out whether my memory is correct about the existence of the other Memorandum Decision or instead be able to confirm that my memory has been completely corrupted from lead poisoning. (Most of my ill-spent youth was spent growing up on the site of a defunct lead-smelting plant in southern Illinois. I blame all of my mistakes on this fact.)]

The aspect of the Chocallo opinion dealing with the ability of the Tax Court to exercise jurisdiction in this situation has been discussed by the Tax Court in TC opinions, see Greene-Thapedi v. Commissioner, 126 T.C. 1, 9 n.13 (2006), and Bussell v. Commissioner, 130 T.C. 222, 245 (2008), but it has never been disavowed by the Court. Thus, it is an open question as to how the Tax Court would rule in a Reviewed Opinion or a TC Opinion by one Division of the Court on the issue of whether the Tax Court can acquire jurisdiction in the fact pattern that was faced by our clients. If the Tax Court does acquire jurisdiction, however, it would appear that it can exercise equitable powers to restore the status quo ante and order the IRS to undo the effects of an illegal levy. See Zapara v. Commissioner, 652 F.3d 1042 (9th Cir.2011), affirming 124 T.C. 223 (2005).

Notwithstanding this uncertainty, there is one step which practitioners can take to increase the chances that the Tax Court will hold that it has acquired jurisdiction in a case where the IRS has taken levy action against an alleged alter ego/successor in interest/transferee of the taxpayer without sending a separate notice of intent to levy to the alleged alter ego/successor in interest/transferee. That step is well illustrated by the opinion in Grover v. Commissioner, T.C. Memo 2007-176, 94 T.C.M. 28 (2007). In Grover, the taxpayer filed a petition asserting that the IRS had issued levies without first sending the taxpayer a §6330 Notice of Intent to Levy.   The IRS moved to dismiss for lack of jurisdiction, based on the grounds that no Notice of Determination had ever been issued to the taxpayer. The IRS also noted that it had previously issued a §6330 Notice of Intent to Levy to the taxpayer well before the taxpayer filed a Tax Court petition.

In dismissing the petition for lack of jurisdiction, the Tax Court stated as follows:

The parties agree that respondent issued no notice of determination. Petitioner does not contend that respondent otherwise made any section 6330 determination. Cf. Chocallo v. Comm’r, T.C. Memo 2004-152 (describing an order denying a motion to dismiss for lack of jurisdiction predicated on the nonissuance of any notice of determination, where the Court had found that the taxpayer had received a “‘determination’ within the contemplation of section 6330” on the basis of “various discrepancies” in the transcripts of account). But as suggested in Boyd v. Comm’r, supra at 303, even if we were to conclude that the notice of levy was “evidence of a concurrent section 6330 determination”, we would be required to dismiss this case for lack of jurisdiction because petitioner did not file his petition until November 17, 2006, which was more than 30 days after the October 9, 2006, notice of levy.

This quote makes clear that, if an alleged alter ego/successor in interest/transferee of a taxpayer wants to have a fighting chance to convince the Tax Court to take jurisdiction over a petition filed in a case where the IRS took levy action against an alleged alter ego/successor in interest/transferee of the taxpayer without first sending a separate §6330 Notice of Intent to Levy to the alleged alter ego/successor in interest/transferee, the alleged alter ego/successor in interest must file the petition within 30 days of the date of the initial IRS levy. In our now-settled Tax Court case, we made sure to file a petition within this 30 day period.

It is possible to argue that a petition filed under these circumstances is timely if filed within 30 days of the date on which the alleged alter ego/successor in interest/transferee receives notice of the levy action. But the prudent course of action is to file a petition within 30 days of the date of the initial levy action if possible.

Even then, it is possible that the Tax Court will end up holding that it lacks jurisdiction in this situation. In our case, we argued in the alternative that, even if the Tax Court lacks jurisdiction in this situation because there was no “determination,” the Tax Court can dismiss the petition for lack of jurisdiction in a way that makes clear that the IRS’s levy action was illegal. I now turn to those alternative arguments.

  1. Alternative Arguments- Getting the Case Dismissed for Lack of Jurisdiction for the Right Reasons

The Tax Court has issued opinions in a number of cases in which taxpayers filed petitions claiming that the IRS had failed to send a §6330 Notice of Intent to Levy to the taxpayer’s last known address before taking levy action. In these situations, the Tax Court has dismissed the petition based on lack of jurisdiction due to the failure of the IRS to send a valid notice of intent to levy prior to taking levy action. See, e.g., Buffano v. Commissioner, T.C. Memo 2007-32, 93 T.C.M. (CCH) 901 (2007). This approach is consistent with the Tax Court’s jurisprudence involving the failure of the IRS to issue a notice of deficiency to a taxpayer’s last known address. See King v. Commissioner, 88 T.C. 1042 (1987), aff’d,  857 F.2d 676 (9th Cir. 1988).

The Ninth Circuit has held that a failure of the Tax Court to explain the reasons for dismissing a petition for lack of jurisdiction where a taxpayer has alleged that the IRS failed to send a notice of deficiency to the taxpayer’s last known address is legal error. See Rosewood Hotel, Inc. v. Commissioner, 275 F.2d 786 (9th Cir. 1960).

In our now-settled case, we argued in the alternative that, if the Tax Court lacked jurisdiction over our petition, it should dismiss the petition for lack of jurisdiction on the grounds that the IRS was required to issue a separate §6330 Notice of Intent to Levy to our client prior to taking levy action and had failed to do so.   We cited to Rosewood and other case law involving for the proposition that the Court could not simply dismiss the petition for lack of jurisdiction without explanation in the face of an argument that the IRS had violated the law by levying on our client’s property without first issuing our client a separate §6330 Notice of Intent to Levy

We also argued in the alternative that the Tax Court should dismiss the petition for lack of jurisdiction on the grounds that the IRS could not pursue levy action at all against our client, because the Code does not permit collection action against an alleged alter ego/successor in interest/transferee in the absence of a judgment (or separate assessment) against the alleged alter ego/successor in interest/transferee. In essence, we raised the argument discussed in Part 3 of this series of blog posts, based on the fact that the IRS could not take administrative collection action against alleged transferees of a taxpayer prior to the enactment of the predecessor to what is now section 6901 of the Code, as another alternative argument.

In raising these arguments, however, we had to deal with the case of Adolphson v. Commissioner, 842 F. 3d 478 (7th Cir. 2016). Adolphson held that the Tax Court erred in cases such as Buffano v. Commissioner, supra, when the Court dismissed the petition for lack of jurisdiction while explaining that Respondent had failed to issue the Notice of Determination to the petitioner’s last known address. The Seventh Circuit held that this latter topic should not have been addressed at all when the Court dismissed the petition for lack of jurisdiction. Instead, per the Seventh Circuit, the Tax Court should have just dismissed the petition for lack of jurisdiction, without further comment.

Ironically, the Seventh Circuit, in reaching its conclusion, violated the very rule which it pronounced in its own opinion. The Seventh Circuit discussed the IRS’s failure to send the Notice of Determination to the petitioner’s “last known address” at length. Aside from the Seventh Circuit’s failure to adhere to its own holding in its opinion, my biggest concern about the Seventh Circuit’s holding is that it permits the IRS to unilaterally deprive taxpayers, along with putative alter egos/successors in interest, of the ability to challenge levy action in the Tax Court. This ruling forces parties to vindicate their CDP rights in District Court, a forum that, since 2006, has no familiarity whatsoever with these rights. The notion that only District Courts, and not the Tax Court, can decide the scope of the Tax Court’s jurisdiction in CDP cases where the IRS refuses or fails to issue a §6330 Notice of Intent to Levy seems to me to be utterly absurd and contrary to Congressional intent.

When we settled our case, we deprived the Tax Court of the opportunity to rule on whether it will continue to follow its prior holding in Buffano in cases which are not appealable to the Seventh Circuit. The Tax Court will face that issue in the not too distant future, and the Tax Court’s holding in that case will impact the ability of alleged alter egos/successors in interest to obtain a dismissal of a petition based on lack of jurisdiction with a discussion and analysis by the Tax Court of the IRS’s alleged procedural irregularities.

If the Tax Court holds that it lacks jurisdiction in these types of cases and, in doing so, follows the holding of the Seventh Circuit in Adolphson, alleged alter egos/successors in interest will be forced to litigate in District Court the question of whether they are entitled to their own independent CDP rights.

This concludes Part 4 of this series. Part 5 of this series will address how these issues can be raised in District Court litigation. Part 5 will also discuss why assertions by the IRS of “nominee” status require a different analysis regarding the potential applicability of the CDP procedures than assertions by the IRS of “alter ego,” “successor in interest” or “transferee” status.   I will also explain why virtually all “nominee” notices of federal tax lien that have been filed by the IRS, along with some “transferee” notices of federal tax lien filed by the IRS, are likely improper in one important respect, to the legal detriment of most, if not all of the persons/entities against whom/which these lien notices have been filed.

 

ARE ALLEGED ALTER EGOS, SUCCESSORS IN INTEREST AND/OR TRANSFEREES ENTITLED TO THEIR OWN COLLECTION DUE PROCESS RIGHTS UNDER SECTIONS 6320 AND 6330? PART 2

Today, guest blogger Lavar Taylor continues his discussion of the interplay of the laws regarding third parties liable for a tax debt and the ability of those third parties to obtain CDP rights. If you have not had the chance to read his initial post on this topic, you might want to take time to read that one before digging into this one. These posts not only explore the ability of these third parties to obtain CDP rights but help anyone not familiar with the various ways that the IRS can seek payment of a taxpayer’s liability to gain a better understanding of the collection process. Keith

In Part 1 of this series of blog posts, I explained how the relevant statutes and regulations, together with the rationale of the Court deciding Pitts v. United States in favor of the IRS, support the conclusion that persons/entities who are alleged by the IRS to be the alter ego, successor in interest, and/or transferee of the party who incurred the tax liability (“original taxpayer”) are entitled to their own independent Collection Due Process (“CDP”) rights under §§ 6320 and 6330 of the Code. In the present blog post, I explain why I believe that the IRS is speaking out of both sides of its mouth when it denies alleged alter egos, successors in interest, and transferees their own independent CDP rights under §§ 6320 and 6330.

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The IRS, in the current version of the Internal Revenue Manual (“IRM”), instructs revenue officers to treat partners in a general partnership which incurred unpaid federal taxes as “persons liable for the tax” for purposes of administratively enforcing the partnership’s unpaid tax liability. Per the IRM, these general partners are to be given CDP Lien and Levy notices under sections 6320 and 6330, in addition to the CDP Lien and Levy notices provided to the taxpayer partnership. Thus, IRM section 5.19.8.4.2(5)(08-05-2016), titled CDP Hearing Requests, provides in section (5) as follows:

If the tax liability involves a partnership, a request for a CDP hearing under IRC 6330 would cover all partners in the partnership. Under IRC 6320, the partnership and partners listed on the NFTL receive the CDP hearing notice. A partner with authority to represent the partnership could request a hearing for the partnership or a partner listed on the NFTL could request a CDP hearing as an individual partner.

Similarly, IRM 8.22.5.3.1.4(4) (03-29-2012), titled Determining Timeliness-Levy, provides that “[f]or partnerships, Collection may issue separate notices to individual partners as well as the partnership entity.” IRM Section 8.22.6.5 (03-29-2012), titled Partnership Liability, states as follows:

1. Under state law, general partners in partnerships are liable for taxes assessed against the partnership. In United States v. Galletti, 541 U.S. 114 (2004), the Supreme Court held the Service’s assessment against a partnership serves to make the general partner liable for the tax. While the Supreme Court did not address administrative collection, Galletti is consistent with the Service’s long-standing legal position that it can enforce a tax lien and take administrative levy action against a general partner based on the assessment and notice and demand directed to the partnership. See Chief Counsel Notice 2005-003 at http://www.irs.gov/pub/irs-ccdm/cc-2005-003.pdf .

2. A partner’s individual CDP hearing request:

— DOES NOT affect Collection’s ability to collect from the partnership or other individual partners’ assets

— DOES affect Collection’s ability to collect from that partner’s individual assets.

Chief Counsel Notice 2005-003 explains in detail the rationale for the IRS’s position that the IRS may pursue administrative collection action against general partners personally for taxes incurred by and assessed against the partnership itself. Essentially, the IRS takes the position that it may take advantage of state law to pursue collection of a tax liability against someone other the person who incurred the tax liability. That concept is not a new one – it is the bedrock of the Supreme Court’s decision in Commissioner v. Stern, 357 U.S. 39 (1958), which deals with the assertion of transferee liability under what is now section 6901 of the Code. In the case of a general partner of a general partnership, the IRS is using the relevant state’s version of the Uniform Partnership Act, which provides that general partners are personally liable for partnership debts.

Why is the IRS speaking out of both sides of its mouth when it grants partners in general partnerships their own CDP rights under §§ 6320 and 6330 with respect to taxes incurred by the partnership but denies those same CDP rights to alleged alter egos, successors in interest and transferees of the original taxpayer? Simply put, the IRS, in seeking to hold third parties liable as the alleged alter ego, successor in interest, and/or transferee of the original taxpayer, is invoking state law to hold a third party liable for the taxes of the original taxpayer.

Conceptually, there is no difference between the IRS invoking state law to hold a general partner of a general partnership liable for the partnership’s tax liability and the IRS invoking state law in an effort to hold someone other than the original taxpayer liable for that tax liability as an alleged alter ego, successor in interest, and/or transferee of the original taxpayer. While determining whether a person or entity is a partner of a general partnership is normally a simpler task than determining whether a person or entity is an alter ego, successor in interest, or transferee of the original taxpayer, both types of determinations involve the application of state law to a given set of facts to determine whether a third party can be held liable for taxes owed by the original taxpayer.

It is clear that state law governs the question of whether a third party can be held liable as an alter ego, successor in interest, and/or transferee of the original taxpayer for taxes assessed against the original taxpayer. See, e.g., Commissioner v. Stern, 357 U.S. 39 (1958) (transferee), Wolfe v. United States, 798 F.2d 1241, (9th Cir. 1986) (alter ego), TFT Galveston Portfolio, Ltd. v. Comm’r, 144 T.C. 96 (2015) (successor in interest), see also Fourth Inv. LP v. United States, 720 F.3d 1058 (9th Cir. 2013) (nominee). It seems to me that, if the IRS’s assertion of liability under state law to enforce a general partnership’s tax liability against a general partner of that partnership is sufficient to trigger CDP rights for the general partner, the IRS’s assertion of liability under state law to enforce a taxpayer’s tax liability against a third party as an alleged alter ego, successor in interest, or transferee should also be sufficient to trigger CDP rights for the alleged alter ego, successor in interest, or transferee.

In the Tax Court cases which we recently settled, the IRS argued that it was not being inconsistent in denying our client (which was an alleged alter ego/successor in interest of the original taxpayer) its own independent CDP rights while allowing those same rights to partners of general partnerships that incur tax liabilities. The IRS argued as follows:

The alter ego doctrine is used in federal tax cases to collect the liability of a taxpayer from a separate corporate entity that is operating to impair the government’s ability to satisfy the taxpayer’s legitimate tax liability. See Oxford Capital Corp. v. United States, 211 F.3d 280, 284 (5th Cir. 2000); Valley Fin. V. United States, 629 F.2d 162, 172 (D.C. Cir. 1980). Once respondent has determined that an entity is an alter ego, that entity’s assets may be levied upon for the debtor of the taxpayer because the law does not recognize the taxpayer and the alter ego entity as each having independent existence for purposes of debt collection. See Oxford Capital Corp., 211 F.3d at 284; see also United States v. Scherping, 187 F.3d 796, 801-02 (8th Cir, 1999).

There are two significant problems with the IRS’s argument (aside from the fact that the IRS’s argument fails to address successor in interest liability). First, there is both federal and California case law which makes clear that an entity is considered a valid, separate entity even when that entity is liable for a third party’s debt under the alter ego doctrine. In Wolfe v. United States, 798 F.2d 1241 (9th Cir. 1986), the Ninth Circuit upheld the application of the alter ego doctrine under Montana law against the shareholder of a corporate taxpayer. In doing so, the Ninth Circuit stated as follows:

Indeed, despite Wolfe’s contentions, it is not necessarily inconsistent to view a corporation as viable for the purpose of assessing a corporation tax, while disregarding it for the purpose of satisfying that assessment. Only those corporations that were established with no valid purpose are considered sham corporations, and thus not entitled to separate taxable status. See Moline Properties v. Commissioner, 319 U.S. 436, 439, 87 L. Ed. 1499, 63 S. Ct. 1132 (1943). A corporation could have a valid business purpose (giving it separate tax status), and at the same time be so dominated by its owner that it could be disregarded under the alter ego doctrine. Cf. National Carbide Corp. v. Commissioner, 336 U.S. 422, 431-434 & n. 13, 93 L. Ed. 779, 69 S. Ct. 726 (1949) (finding insignificant, for the purpose of determining whether a subsidiary corporation is entitled to separate taxable status, the fact that the owner retains direction of the subsidiary’s affairs, provides all of its assets, taxes all its profits, and exercises complete domination and control over its business). This view has been adopted by the Fifth Circuit. See Harris v. United States, 764 F.2d 1126, 1128 (5th Cir. 1985) whether or not [the corporation] was a separate taxable entity is not the same question as whether it was an alter ego for the purpose of piercing the corporate veil”).

Thus, Wolfe, and the cases cited in the Wolfe opinion, make clear that a corporation can be a valid, separate entity from the original taxpayer for purposes of the CDP procedures, even if the IRS is seeking to hold a corporation liable under the alter ego doctrine for the taxes owed by the original taxpayer.

Similarly, California law, upon which the IRS was relying in the now-settled cases we were handling in Tax Court, makes clear that a third party entity which is held liable as the “alter ego” of the original obligor remains a valid, independent entity for purposes of California law. In Mesler v. Bragg Management Co., 39 Cal. 3d 290 (1985), the California Supreme Court made this point very clear while holding that a parent corporation could be sued as the alleged alter ego of its subsidiary, even though the plaintiff had previously reached a settlement agreement with the subsidiary. The Court stated in relevant part as follows:

[W]hen a court disregards the corporate entity, it does not dissolve the corporation. “It is often said that the court will disregard the ‘fiction’ of the corporate entity, or will ‘pierce the corporate veil.’ Some writers have criticized this statement, contending that the corporate entity is not a fiction, and that the doctrine merely limits the exercise of the corporate privilege to prevent its abuse.” (6 Witkin, op. cit. supra, §5, at p. 4317; see, e.g., Comment, supra, 13 Cal. L.Rev. at p. 237.)

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The essence of the alter ego doctrine is that justice be done. “What the formula comes down to, once shorn of verbiage about control, instrumentality, agency, and corporate entity, is that liability is imposed to reach an equitable result.” (Latty, Subsidiaries and Affiliated Corporations (1936) p. 191.) Thus the corporate form will be disregarded only in narrowly defined circumstances and only when the ends of justice so require.

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It is not that a corporation will be held liable for the acts of another corporation because there is really only one corporation. Rather, it is that under certain circumstances a hole will be drilled in the wall of limited liability erected by the corporate form; for all purposes other than that for which the hole was drilled, the wall still stands. 39 Cal. 3d at 300-301.

To the extent that state law is relevant in this context, California law supports the conclusion that an alleged alter ego is a separate entity which is entitled to its own independent CPD rights. (For taxpayers located outside of California, and outside of the Ninth Circuit, the relevant case law will obviously be different.)

The second problem with the IRS’s argument is that the two cases which it cited both pre-date the CDP procedures, which took effect in January of 1999, following the enactment of RRA 1998 in July, 1998. The resolution of the question of whether an alleged alter ego, successor in interest, or transferee of the original taxpayer is entitled their own independent CDP rights will likely depend on the statutory interpretation of the CDP provisions, §§ 6320 and 6330. There are no cases which address this issue. And as is explained in Part 1 of this series of blog posts, the question of how to interpret §§ 6320 and 6330 is likely to be influenced by looking to §§ 6321 and 6331.

Notably, § 6331 refers to the need to provide a “notice and demand” before levy action may be pursued. This is a reference to “notice and demand” as set forth in IRC § 6303(a), which requires the IRS to provide “notice to each person liable for the unpaid tax, stating the amount and demanding payment thereof.” This notice must be sent to the person’s “last known address” within 60 days of the date on which the tax is assessed. Id. Failure to give a valid notice and demand renders void any levy action by the IRS and requires the IRS to refund all monies collected by levy. See Martinez v. United States, 669 F.2d 568 (9th Cir. 1981) (IRS was required to return all funds received by levy where IRS failed to give taxpayer a valid notice and demand under § 6303(a) prior to issuing levies). Failure to give a proper notice and demand also prevents the IRS from taking future administrative enforcement actions such as filing lien notices and issuing levies. See United States v. Coson, 286 F.2d 453 (9th Cir. 1963) (failure to send proper notice and demand to putative partner of a general partnership rendered tax lien void), United States v. Chila, 871 F.2d 1015 (11th Cir. 1989), cert. denied, 493 U.S. 975 (1989) (failure of the IRS to send a valid notice and demand to the taxpayer precludes the IRS from taking administrative collection action with respect to the unpaid taxes but does not prevent a suit to reduce the assessment to judgment), Blackston v. United States, 778 F.Supp. 244 (D. Md. 1991) (Marvin Garbis, J.).

There is a further requirement that the IRS send a notice of intent to levy under IRC § 6331(d) at least 30 days before the IRS levies “upon the salary or wages or property of any person with respect to any unpaid tax.” This requirement, largely forgotten since the enactment of section 6330, has never been repealed. Its primary significance now is that the sending of this notice triggers an increase in the accrual rate of the failure to pay penalty under IRC §§ 6651(a)(2) and (a) (3). See IRC § 6651(d)(1).

The language of §§ 6303(a) and 6331(d) is similar to the language used in §§ 6320 and 6330. Yet we know that the IRS does not send a “notice and demand” for payment under § 6303(a) within 60 days of the date of assessment to alleged alter egos, successors in interest, or transferees who have not been separately assessed that tax liability. Similarly, we know that the IRS does not send § 6331(d) notices to alleged alter egos, successors in interest, or transferees prior to issuing levies against the property of alleged alter egos, successors in interest, or transferees. How is it that the IRS is able to take administrative collection action against alleged alter egos, successors in interest, and/or transferees without complying with §§ 6303(a) and 6331(d)?

The answer to that apparent conundrum may surprise you. While it is possible to argue that the IRS may take administrative collection action against alleged alter egos, successors in interest, and/or transferees who have not been separately assessed a tax liability without complying with the requirements of §§ 6303(a) and 6331(d), it is far from clear that this argument carries the day. There are other arguments, some of which, in my view, have not been properly articulated in recent years. Perhaps Pitts was incorrectly decided, and the IRS is not entitled to take administrative collection action against alleged alter egos, successors in interest, or transferees at all. That topic will be explored in greater detail in Part 3 of this series.

 

 

 

Priority Status of Transferee Liability in Bankruptcy

Two types of claims exist in bankruptcy – secured and unsecured. Every creditor wants to be a secured creditor. In theory, secured creditors pass through bankruptcy unaffected. That theory has many notable exceptions but, nonetheless, it is best to be a secured creditor.

If you cannot be a secured creditor, the next best thing is to be a priority creditor. Congress has looked at the type of debts that exist in the United States and decided that certain of those debts, about ten, deserve recognition above all the rest. It lists these special “priority” debts in section 507 of the bankruptcy code. If your debt makes it onto this list, your debt gets paid before general unsecured claims receive payment. The higher you are on the list, the better you are. Think of the list of priority debts as a cruise ship with the best cabins at the top and the worst at the bottom. Then think of general unsecured claims as steerage existing in the hold of the ship below all of the priority claims. Depending on when the money in the estate runs out, only certain creditors get paid. All of the creditors in the first priority must be paid before any payments go to the next level down, and so on through each level. Wherever the money runs out, the creditors in the group where it runs out get paid pro rata and any creditors below that level go home empty handed.

It is in this context that the fight in In re Kardash, No. 8:16-bk-05715 (September 21, 2017) takes place. The IRS convinced the Tax Court to hold in T.C. Memo 2015-51 and T.C. Memo 2015-197 that he owed about $4.3 million as a result of fraudulent transfers, and the 11th Circuit affirmed the Tax Court’s decisions at 866 F.3d 1249 (11th Cir. 2017). For more background on the Tax Court aspect of this case see Steve’s prior post here and a subsequent post about the case by Peter Reilly here. The IRS seeks to have the transferee liability of Mr. Kardash treated as a priority claim in his bankruptcy case (although he is married Mr. Kardash filed a chapter 11 bankruptcy individually and his wife did not file). Mr. Kardash objected to treating the transferee liability as a priority claim. Usually, it is the trustee who cares more than the debtor, but there is a second importance to priority status for tax claims because any tax claim entitled to priority status is excepted from discharge if it does not get paid in the bankruptcy case. Tax debts not entitled to priority status can also be excepted from discharge but the rules for those debts are more restrictive. So, the classification of the claim makes a big difference both to the other creditors of the estate and, potentially, to Mr. Kardash.

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Mr. Kardash was an employee and minority shareholder with an 8.65 share of a company that was defunct by the time of the bankruptcy case. He managed the operations of the company but was not a responsible person under IRC 6672. (If he did owe any money as a responsible person, such a debt would always be entitled to priority status under bankruptcy code 507(a)(8)(C)). During the relevant period, the company had revenue in excess of $450 million but paid no income taxes. The IRS subsequently audited the company and determined that it owed over $120 million for these years. The two controlling shareholders siphoned substantially all of the cash out of the company. Mr. Kardash received about $3.5 million during the years 2005-2007, and he reported the distributions as dividends and paid tax on it.

The IRS sent him a notice of transferee liability regarding these dividends as well as bonuses he received in 2003 and 2004. He petitioned the Tax Court, which ruled that the dividends paid to him in 2005-2007 were fraudulent transfers under applicable Florida law because they were not made in compensation for his services and the company was either insolvent at the time it paid him or became insolvent as a result of the payments.

The IRS can file a priority claim under bankruptcy code 507(a)(8)(A) for unsecured claims for “a tax on or measured by income or gross receipts for a taxable year ending on or before the date of the filing of the petition….” The bankruptcy court states that the transferee liability under IRC 6901(a) (the basis for Mr. Kardash’s liability) does not by its terms impose a tax. While this is a true statement, the transferee liability provisions seek to provide the IRS with a basis for collecting tax that has otherwise gone unpaid. The bankruptcy court quotes from the Tax Court’s description of the case:

“Section 6901(a) is a procedural statute authorizing the assessment of a transferee liability in the same manner and subject to the same provisions and limitations as in the case of the taxes with respect to which the transferee liability was incurred. Section 6901(a) does not create or define a substantive liability but merely provides the Commissioner a remedy for enforcing and collecting from the transferee of the property the transferor’s existing liability.”

The bankruptcy court points to an 11th Circuit decision in Baptiste v. Commissioner, 29 F.3d 1533 (11th Cir. 1994), holding that “any liability to which section 6901(a) applies is not a tax liability, but rather an independent liability.” The 11th Circuit found that IRC 6901(a) is purely a procedural statute. The Baptiste case was not a bankruptcy case; however, in In re Pert, 201 B.R. 316, 320 (Bankr. M.D. Fla. 1996), a bankruptcy court in the same jurisdiction as the court deciding Mr. Kardash’s case relied upon Baptiste in determining that a transferee liability was not entitled to priority status. The bankruptcy court states that the Baptiste and Pert decisions control the decision here. I do not necessarily agree with that statement as the Circuit Court decision addresses a different aspect of a transferee liability and a bankruptcy court is not bound by decisions of bankruptcy judges at the same level. Nonetheless, these cases provide support for the decision that the transferee liability is not entitled to priority status.

The Court disagrees with the decision of the 10th Circuit in McKowen v. Internal Revenue Service, 370 F.3d 1023 (10th Cir. 2004). The McKowen case involved the issue of discharge and not directly the issue of priority status, though the two can be linked. The McKowen case adopted a functional approach to the classification of the transferee liability claim which is the approach sought by the IRS. A middle ground here would be to treat the debt as non-priority but excepted from discharge similar to debts where a fraudulent return has been filed. Such treatment would allow other creditors of the estate to take before the payment of the derivative liability created by 6901(a), but would also allow the IRS to have the opportunity to collect on a debt that the actions of the company owing the debt has prevented the IRS from collecting. Neither the priority provision of bankruptcy code section 507 nor the discharge provisions of bankruptcy code section 523 neatly address the circumstances of a transferee liability. It is surprising that almost 40 years after the passage of the bankruptcy code, an issue of this type remains unresolved.

In arguing that the court should apply a functional analysis in determining whether the transferee liability receives priority status the IRS cited to United States v. Reorganized CF&I Fabricators of Utah, Inc., 518 U.S. 213 (1996) in support of its position that a bankruptcy court must look to the basis for a liability in determining the liabilities status. In CF&I the Supreme Court determined that a liability labeled a tax was really a penalty just as in Sotelo v. United States, 436 U.S. 268 (1978)(in a case involving the trust fund recovery penalty) the Supreme Court found a liability labeled a penalty was really a tax. See a post by Bryan Camp discussing this issue for further details. As you can see from the fact that cases have twice gone to the Supreme Court to classify tax claims, this is a serious issue. The parties’ briefs are excellent and set out the issue in great detail if you are seeking more understanding of the issue. See Debtor’s Response and Opposition to the IRS’S Motion for Summary Judgment and the Reply to Debtor’s Response and Opposition to the United States’ Motion for Summary Judgment.

Conclusion

I look for the IRS to appeal this decision unless it determines that the 11th Circuit precedent controls the issue. The decision here does not directly address discharge but only the priority of the IRS claim. Depending on the amount of money in the estate, the priority status of the claim may not matter as much as the discharge issue. From the pleadings it appears that the efforts of the IRS to collect from Mr. Kardash partially involves its ability to reach property held as tenancy by the entireties based on the decision in United States v. Craft, 535 U.S. 274 (2002) and a subsequent 11th Circuit case, United States v. Offiler, 336 F. App’x 907, 909 (11th Cir. 2009) interpreting Craft. I wrote about the Craft case here.

A part of the fight in the bankruptcy case involves use of the proceeds of a house that the taxpayer and his wife jointly owned. The IRS objected to certain uses of those proceeds because the debtor’s proposed use would reduce its recovery. The debtor is 75 and now on social security. The prospects for recovery here will come from existing property and not future income but the IRS may determine that its ability to collect from Mr. Kardash is less important than establishing the principle regarding the classification of transferee liabilities in bankruptcy cases. If it does, Mr. Kardash will not only have selected bad business partners but also a bad issue to litigate since the IRS may push the litigation without his concern for the cost vs. benefit.

 

 

 

 

Tax Court Petitioners in Transferee Cases Cannot Extract Themselves from the Case Once the Petition is Filed

Section 7459 contains an important feature of Tax Court that gets little attention. In Schussel v. Commissioner, 149 T.C. No. 16, the Court provided another glimpse at the importance of this section. Here, as in earlier cases involving section 7459, the Court must determine whether its jurisdiction over transferee liability cases invokes the restriction on dismissal contained in that section. In Schussel, a case of first impression, the Tax Court finds that transferee cases like deficiency cases, and generally unlike cases in which the Tax Court’s jurisdiction comes through a notice of determination, require a decision regarding the amount of the liability which prevents a taxpayer from voluntarily dismissing the case in hopes of starting over later or starting elsewhere.

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We have previously discussed this issue in the context of collection due process (CDP).   CDP cases start with a notice of determination. In Wagner v. Commissioner, 118 T.C. 330 (2002), the Tax Court held that a taxpayer who brings a CDP petition can request a dismissal of the case without having the Court reach a decision. The Wagner case distinguished Estate of Ming, 62 T.C. 519 (1974), which held that a taxpayer petitioning the Tax Court under IRC 6213 may not withdraw the petition in order to avoid the entry of decision. In other words, once a taxpayer is properly in a Tax Court case caused by a notice of deficiency, the only door out of the Court is a door that says how much the taxpayer owes.

Over the years, I have had a number of taxpayers rejoice at the dismissal of their case because they thought dismissal meant that did not owe any taxes. In the Tax Court, in a deficiency case, it means just the opposite. If jurisdiction attaches and the Tax Court dismisses the case, the taxpayer owes the full amount of the deficiency. This result may seem harsh or counterintuitive, but it puts the taxpayer in the same place the taxpayer would be if the taxpayer did not file a Tax Court petition. The result comes directly from the language of IRC 7459 which provides:

If a petition for redetermination of a deficiency has been filed by the taxpayer, a decision of the Tax Court dismissing the proceeding shall be considered as a decision that the deficiency is the amount determined by the Secretary. An order specifying such amount shall be entered in the records of the Tax Court unless the Tax Court cannot determine such amount from the record in this proceeding, or unless the dismissal is for lack of jurisdiction.

The decision of the Tax Court in Wagner holding that section 7459 did not apply in CDP cases was extended to stand alone innocent spouse cases, in Davidson v. Commissioner, 144 T.C. 273 (2015), and to whistleblower award cases, in Jacobson v. Commissioner, 148 T.C. 4 (Feb. 8, 2017). Mr. Schussel argued that the Tax Court’s jurisdiction under IRC 6901(a) for transferee liability cases more closely resembled the cases finding section 7459 inapplicable than it did deficiency cases.

Section 6901(a) provides that:

The amounts of the following liabilities shall, except as hereinafter in this section provided, be assessed, paid, and collected in the same manner and subject to the same provisions and limitations as in the case of the taxes with respect to which the liabilities were incurred:

  • Income, estate, and gift taxes.-
  • – The liability, at law or in equity, of a transferee of property –
  • Of a taxpayer in the case of a tax imposed by subtitle A (relating to income taxes),
  • Of a decedent in the case of a tax imposed by chapter 11 (related to estate taxes), or
  • Of a donor in the case of a tax imposed by chapter 12 (related to gift taxes),

In respect of the tax imposed by subtitle A or B.

(b) Liability. – Any liability referred to in subsection (a) may be either as to the amount of tax shown on a return or as to any deficiency or underpayment of any tax.

(f) Suspension of Running of Period of Limitations. – The running of the period of limitations upon the assessment of the liability of a transferee or fiduciary shall, after the mailing to the transferee or fiduciary of the notice provided for in section 6212 (relating to income, estate, and gift taxes), be suspended for the period during which the Secretary is prohibited from making the assessment in respect of the liability of the transferee or fiduciary (and, in any event, if a proceeding in respect of the liability is placed on the docket of the Tax Court, until the decision of the Tax Court becomes final), and for 60 days thereafter.

The language of the statute and the language of the regulations under the statute make transferee cases very much like deficiency cases. The Court also cited several cases going back to 1930 holding that the review in transferee cases is similar to the review in deficiency cases. The history of transferee liability places in back in time to the creation of the Tax Court, unlike the types of jurisdiction given to the Tax Court in 1998 and 2006, with respect to the types of cases that do not implicate section 7459.

The Court rejected petitioner’s argument that the parties had reached an agreement regarding the amount of his transferee liability which allowed the parties to move on without the need for a Tax Court decision. The Court stated that “it is incumbent upon them [the parties] to stipulate a decision reflecting that amount.”  The decision here places transferee cases on the same footing with deficiency proceedings.  If a taxpayer timely files a petition in a deficiency or a transferee case such that the Tax Court has jurisdiction over the case, the taxpayer must recognize that the end result of filing that petition will be a decision document determining the taxpayer’s liability, or lack of liability, with respect to the periods at issue in the case.

Conclusion

The importance of IRC 7459 in the Tax Court’s responsibility toward cases coming before it has importance in determining what is jurisdictional. We have blogged before about cases in which the Harvard Tax Clinic argues that time periods for filing Tax Court petitions are not jurisdictional but are claims processing rules. The cases in which Harvard has made this argument have been CDP cases and stand alone innocent spouse cases where section 7459 does not apply. If section 7459 applies, the dismissal of a case can have immediate tax consequences for a taxpayer. The Seventh Circuit case, Tilden v. Commissioner, which examined the Supreme Court legislation regarding time periods and applied it sua sponte to a deficiency case, did not mention this issue. Before arguing that the time period for filing a petition after receipt of a notice of deficiency or a notice of transferee liability is not jurisdictional but only a claims processing rule, the petitioner must carefully think through the implications of section 7459 on the outcome of the cases in which the Tax Court finds no basis for equitably tolling the statute.

 

Why Would the Service Stop Me From Paying Someone Else’s Taxes?

That is an incredibly misleading title.  You obviously can pay someone else’s taxes.  And, its fairly common to do so.  Executives often have their taxes on certain compensation paid by their employer.  I am sure it is also common for a relative to pay taxes for someone if they cannot pay it themselves.  Depending on the circumstances, this may create additional tax issues to work through.  For instance, if an employer pays tax for an employee, it will give rise to additional taxable income, on which you must pay tax…and if the employer pays that tax, it will give rise to taxable income, on which you must pay tax…and so on.  Here is an old Slate article discussing just this in the context of a Survivor winner Richard Hatch.  I vaguely recall he was sort of a jackass, and got dinged for tax evasion.   If a family member pays your taxes, it is likely a gift, giving rise to potential gift tax issues.

So, why the B.S. misleading post title?  Tax procedure.  The government released Legal Advice issued by Field Attorneys (LAFA) 20171801F earlier this month, which considered two questions:

  • May a person making a deposit under I.R.C. § 6603 for a potential transferee liability direct the Service to apply all or a portion of its deposit against the liability of another person liable for the same underlying liability?

  • If a person making a deposit is permitted to apply all or a portion of the deposit to the liability of another person liable, under these facts, may an attorney-in-fact for a person making a deposit under I.R.C. § 6603 direct the Service to transfer the deposit to pay another person’s tax liability?

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Based on the title you can probably guess the IRS position on this.  First, though, it might be worth a quick note on what a LAFA is, since this is probably the first time we have devoted a full post to one and perhaps the first time we have discussed them in general. This is advice written by field counsel for local field employees.  As it was not issued by the National Office, it is not Chief Counsel Advice (“CCA”).  We touch on CCAs somewhat frequently.  As defined by the Code, for disclosure purposes, CCAs are:

written advice or instruction, under whatever name or designation, prepared by any national office component of the Office of Chief Counsel which (i) is issued to field or service center employees of the Service or regional or district employees of the Office of Chief Counsel; and (ii) conveys… any legal interpretation of a revenue provision; any Internal Revenue Service or Office of Chief Counsel position or policy concerning a revenue provision; or any legal interpretation of State law, foreign law, or other Federal law relating to the assessment or collection of any liability under a revenue provision.

As such, CCAs often indicate the official IRS position on a matter.  Under the above definition, most field counsel advice is not required to be released, but sometimes the field counsel will seek review by the National Office.  The review probably (definitely?) still does not make the field advice a CCA, but it is generally released to the public anyway.

In the LAFA, the Service determined that no, the depositor could not direct the deposit to be used to pay the liability of another person liable for the tax underlying debt. Although that effectively answers both questions, since the second is contingent on the first, the LAFA also stated the transfer of a deposit could not be done by a POA if it were possible to transfer deposits.

So, what is going on here?  The LAFA is short on facts.  Those two pages are completely redacted.  It appears that there was transferee liability under Section 6901 from a transferor to a transferee (transferee 1), and then to another transferee (transferee 2).  I believe this was a subsequent transfer of the same assets, and transferee 2 was attempting to transfer its deposit to transferee 1. Section 6901 is a procedural provision that allows collection from a transferee based on liability under another federal or state law, so the liability could be for any number of reasons, and I am not sure what it was in this case.  The subsequent transferee, transferee 2, made a deposit for the potential tax outstanding under Section 6603, which allows for deposits to be made on potential outstanding tax.

In making the deposit, transferee 2 stopped interest from running on the potential tax debt, and potentially generated some interest payable to transferee 2 if the amount was returned (it also keeps things out of the refund procedures and statute of limitations).  Transferee 2 apparently was not the person who was going to end up paying the outstanding tax, and sought to transfer the deposit to the transferee 1, who presumably was going to pay the tax.  And, presumably had not made a deposit (or had not deposited sufficient funds).  Since transferee 2 could pay transferee 1’s tax debt, it seems conceivable that transferee 2 should be able to transfer its deposit to transferee 1.

The LAFA’s position, however, was that:

While a person making a deposit may direct the Service to use the deposit as payment of other of his liabilities, Rev. Proc. 2005-18 does not authorize a person to direct the Service to apply a deposit to pay another person’s liability.

Section 6603, which allows for deposits, states a “taxpayer may make a cash deposit…which may be used by the Secretary to pay any tax imposed…which has not been assessed at the time of the deposit.  Such a deposit shall be made in such manner as the Secretary shall prescribe.”  This language doesn’t necessarily preclude the transfer of the deposit to another taxpayer.

In the LAFA, the Service reviewed Rev. Proc. 2005-18 for the Service’s self-prescribed procedural rules under Section 6603.  The Rev. Proc. does have language that treats Section 6603 as allowing deposits for the taxpayer’s tax debts, and not that of others, or potentially shared debts.  It also states that the deposit does not constitute a payment until it is applied against an “assessed tax of the taxpayer.”  But, the Rev. Proc. does also allow the taxpayer to allocate deposit amounts against other assessments, and does not specify the assessments must be that of the taxpayer in other language.

The LAFA concludes though that while transferee liability is derivative of the transferor’s liability, multiple transferees may be liable for different debts, which it believed was evidence that transferees should not be able to transfer deposits.  Further, the Service’s own current guidance does not allow for such a transfer, which it deemed was sufficient reason to preclude the deposit transfer.  The guidance essentially says transferee 2 needs to request the deposit back, and then use the funds to pay the debt of transferee 1.  This does not, however, stop the underpayment interest of transferee 1 from accruing (although transferee 2 might be entitled to overpayment interest, if certain requirements were met – the overpayment and underpayment rates, however, are not necessarily the same.  For those who wish to learn more about deposits, payments, and interest rates, Chapter 6.06 and Chapter 11.05 of SaltzBook were recently updated and they cover these topics in great detail).

As to the POA issue, the guidance indicates that, even if a deposit could be transferred, the Form 2848 does not specifically allow for that action, and therefore would not be authorized.

So, what does this mean?  You clearly can pay someone else’s taxes, but the Service position is that a deposit cannot be shifted between taxpayers.  The reasoning is based on the Service’s own guidance, and not the statute.  For multiple parties potentially responsible for the same tax, to stop interest from running each will need to make a deposit of his, her, or its own maximum liability amount.

Transferee Liability and the Application of Federal versus State Law

We welcome back guest blogger Marilyn Ames.  Marilyn has retired from the Office of Chief Counsel, IRS to the 49th state where she enjoys shoveling snow and other outdoor activities.  She also works with me on the collection chapters of the Saltzman and Book treatise, IRS Practice and Procedure.  Today, she writes about a recent case in which the IRS asserted transferee liability.  Based on the number of transferee cases I am seeing, I believe that the IRS has stepped up activity in this area over the past couple of years.  For those of you interested in transferee liability, Marilyn wrote an earlier post on the subject that you may also want to view.  Keith

In an opinion issued on December 16, 2016, the Seventh Circuit Court of Appeals played Grinch in Eriem Surgical, Inc. v. United States and gifted the Internal Revenue Service and the taxpayer with an opinion calculated to make both unhappy.  The opinion can be found here and at 843 F3d 1160.

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Eriem Surgical purchased the inventory of Micrins Surgical, Inc. when it went out of business in 2009 without paying its taxes.  Eriem also took over Micrins’ office space, hired its employees, used its website and telephone number, and continued Micrins’ business of selling surgical instruments.  Eriem also used the name “Micrins” as a trademark, and Bernard Teiz, the former president of Micrins, continued to play a leading role in Eriem’s business. All of this raised the suspicions of the Internal Revenue Service, although Mr. Teitz attempted to quell those suspicions by having his wife hold the 40% interest in Eriem that he formerly held in Micrins.  But this was not enough, and the Internal Revenue Service concluded that Micrins had simply morphed into Eriem, and levied on Eriem’s bank account and receivables.  Eriem then filed a wrong levy suit under 26 USC §7426(a)(1). The district court applied Illinois state law to determine that Eriem was a successor to Micrins, and as such, was liable for Micrins taxes.  Although Eriem appealed, the United States used this as an opportunity to make an argument that the courts have rejected up to this time.

The courts have long held that whether a third party is liable under some doctrine of transferee liability is dependent on state law. However, for the past few years, the Internal Revenue Service has taken the position that federal common law should govern whether a third party is the alter ego of the taxpayer, arguing that the application of state law leads to different results depending on the law of the applicable state and, consequently, to disparate treatment of taxpayers in essentially the same position. In staking out this position, the IRS has relied in part on United States v. Kimbell Foods, Inc., 440 US 715 (1979) and Drye v. United States, 528 US 49 (1999). The Service’s argument can be found in Chief Counsel Notice 2012-002 (Dec. 2, 2011), which can be located here.  The essence of the Service’s position is that state law should not control in an alter ego dispute, as the question is not one of property rights, but is an issue of the identity of the taxpayer. Since the IRS is ultimately interested in reaching property, not just engaging in identification of the taxpayer, this seems to some extent to be a distinction without a difference – at least without a difference that would matter to the third party/taxpayer.

On appeal, the Seventh Circuit confronted the question of whether state or federal law governed with respect to corporate successorship, and held that since the Internal Revenue Code does not say anything about this issue, “it seems best to apply state law.”  The court held that Kimbell Foods is not dispositive, as the Supreme Court has failed to cite it in later cases for the proposition that federal law controls, and that Drye expressly states that “in tax cases state law determines the taxpayer’s rights in property that the IRS seeks to reach.” Although it is not clear from the opinion if the United States argued that this was really just a case of identity, it’s doubtful that the court would have bought the argument, given that this case was really about the IRS cleaning out Eriem’s bank account.  The Seventh Circuit affirmed the district court’s application of Illinois law, thus ensuring that Mr. Teitz and Eriem were also unhappy with the result.

In an interesting sideshow to the federal/state law question, the Seventh Circuit also rejected Eriem’s argument that the 40% change in ownership had “dispositive significance.” Although Illinois law holds that a complete change of ownership prevents a finding of successorship, the Seventh Circuit affirmed the district court’s conclusion that Mrs. Teitz was serving as a proxy for her husband, and so the purported change in ownership was irrelevant.

Whether the IRS and the Department of Justice will continue to argue that there is a federal common law that should determine when a third party is an alter ego for purposes of tax collection remains to be seen, since it has not been popular with the courts.  In most cases, it doesn’t seem to make a difference to the end result, and may simply be a cut-and-paste argument the government is making to bolster its position.

Summary Opinions — Catch Up Part 1

Playing a little catch up here, and covering some items from the beginning of the year.  I got a little held up working on a new chapter for SaltzBook, and a supplement update for the same.  Both are now behind us, and below is a summary of a few key tax procedure items that we didn’t otherwise cover in January.  Another edition of SumOp will follow shortly with some other items from February and March.

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  • In CCA 201603031, Counsel suggests various procedures for the future IRS policy and calculations for the penalty for intentional failure to file electronically.  The advice acknowledges there is no current guidance…I wrote this will staring at my paper 1040 sitting right next to my computer.  Seems silly to do it in pencil, and then fill it into the computer so I can file electronically.
  • This item is actually from March.  Agostino and Associates published its March newsletter.  As our readers know, I am a huge fan of this monthly publication.  Great content on reducing discharge of indebtedness income and taxation.  Also an interesting looking item on representing real estate investors, which I haven’t had a chance to read yet, but I suspect is very good.
  • The IRS has issued a memo regarding its decision to apply the church audit restrictions found under Section 7611 (relating to exemption and UBI issues) to employment tax issues with churches also.
  • Panama Papers are all the rage, but I know most of you are much more interested in Iggy Azalea’s cheating problems (tax and beau).  Her Laker fiancé was recorded by his teammate bragging about stepping out and she had a sizable tax lien slapped against her for failure to pay.  She has threatened to separate said significant other from reproductive parts of his body, but it appears she has approached the tax debt with a slightly more level head, agreeing to an installment agreement.
  • I’m a rebel, clearly without a cause.  I often wear mismatched socks, rarely take vitamins, and always exceed the speed limit by about 6 MPH.  But, professionally, much of my life is about helping people follow the rules.  In Gemperle v. Comm’r, the taxpayers followed the difficult part of the conservation easement rules, and obtained a valid appraisal of the value, but failed to follow the simple rule of including it with his return.  Section 170(h)(4)(B)(iii) is fairly clear in stating the qualified appraisal of the qualified property interest must be included with the return for the year in question.  And, the taxpayers failed to bring the appraiser to the hearing as a witness, allowing the IRS to argue that the taxpayer could not put the appraisal into evidence because there was no ability to cross examine.  In the end, the deduction was disallowed, and the gross valuation misstatement penalty was imposed under Section 6662(h) of 40%.  The Section 6662(a) penalty also applied, but cannot be stacked on top of the 40% penalty pursuant to Reg. 1.6662-2(c).  The Court found that there was no reasonable cause because the taxpayer failed to include the appraisal on the return, so, although relying on an expert, the failure to include the same showed to the Court a lack of good faith.  Yikes! Know the rules and follow them. It is understandable that someone could get tripped up in this area, as other areas, such as gift tax returns, have different rules, where a summary is sufficient (but perhaps not recommended).
  • The Shockleys are fighting hard against the transferee liability from their corporation.  Last year we discussed their case relating to the two prong state and federal tests  required for transferee liability under Section 6901.  In January, the Shockleys had another loss, this time with the Tax Court concluding they were still liable even though the notice of transferee liability was incorrectly titled and had other flaws.  Overall, the Court found that it met and exceed the notice requirements and the taxpayer was not harmed.
  • The Tax Court, in Endeavor Partners Fund, LLC v. Commissioner, rejected a partnership’s motion for injunction to prevent the IRS from taking administrative action against its tax partner.  The partnership argued that allowing the IRS to investigate the tax matters partner for items related to the Tax Court case (where he was not a party) would “interfere with [the Tax] Court’s jurisdiction” because the Service could be making decisions on matters the Court was considering.  The Court was not troubled by this claim, and held it lacked jurisdiction over the matters raised against the tax matters partner, and, further, the partnership’s request did not fall within an exception to the Anti-Injunction Act.
  • Wow, a financial disability case where the taxpayer didn’t lose (yet).  Check out this 2013 post by Keith (one of our first), dealing with the IRS’s win streak with financial disability claims.  Under Section 6511(h), a taxpayer can possibly toll the statute of limitations on refunds with a showing of financial disability.  From the case, “the law defines “financially disabled” as when an “individual is unable to manage his financial affairs by reason of a medically determinable physical or mental impairment … which has lasted or can be expected to last for a continuous period of not less than 12 months,” and provides that “[a]n individual shall not be considered to have such an impairment unless proof of the existence thereof is furnished in such form and manner as the Secretary may require.””  I’ve had some success with these cases in the past, but I also had my ducks in a row, and compelling facts.  So, not something the IRS would want to argue before a judge.  The Service gets to pick and choose what goes up, which is why it wins.  In LeJeune v. United States, the District Court for the District of Minnesota did not grant the government’s motion for summary judgement, and directed further briefing and hearing on whether the taxpayer’s met their administrative requirements.
  • Another initial taxpayer victory, which could result in an eventual loss, but this time dealing with TFRP under Section 6672.  In Hudak v. United States, the District Court for the District of Maryland dismissed the IRS’s motion for summary Judgement, finding that a jury could determine that a CFO (here Mr. Mules) was not a responsible person with the ability to pay.  The CFO admitted he knew the company wasn’t complying with its employment tax obligations, and knew other creditors were being paid.  He alleged, however, that he lacked the ability (as CFO) to make the required payments…seems like an uphill battle.  He could win though, as the contention is that the owner/CEO/President (Mr. Hudak) made those decisions, had that authority, and misled the CFO to believe the payments were made.  Neither side will likely be able to put much past the Court in this matter, as Judge Marvin Garbis is presiding (he who authored various books on tax, including Cases and Materials on Tax Procedure and Tax Fraud and Federal Tax Litigation).