Holding Transferees Liable Without a Transferee Assessment

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We welcome back guest blogger Marilyn Ames my former colleague at Chief Counsel, IRS and my current colleague in updating the Saltzman and Book treatise, “IRS Practice and Procedure.”  You can find a detailed discussion of transferee issues in the treatise.  Keith

In yet another case involving an intermediary transaction tax shelter, the Eleventh Circuit Court of Appeals reaches back to a 1933 Supreme Court case to show how broad the government’s powers to reach transferees of a taxpayer’s assets are.  In United States v. Henco Holding Corp., 127 AFTR2d 2021-362, 2021 WL 165324 (11th Cir. 2021), the shareholders of a corporation arranged a transaction in which a third-party purchaser received the assets of a corporation, an intermediary received a fee for participating in the transaction, the shareholders received the net cash from the asset sale, and the government was left with an empty bag when the corporate taxpayer could not pay the capital gains tax on the sale, which occurred in 1997.  The Internal Revenue Service audited the return of the corporate taxpayer, Henco Holding Corporation, and after several extensions of the statute of limitations, issued a notice of deficiency to Henco in 2007 with respect to the sale transaction in an amount over $56 million. Henco defaulted on the notice of deficiency, but requested a collection due process hearing when the IRS began collection procedures. When the collection activity was sustained by Appeals and a notice of determination was issued, Henco then filed a petition with the Tax Court challenging both the collection action and the underlying tax liability. The Tax Court sustained both the assessments and the IRS collection action.

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With Henco having no assets from which to pay, the IRS eventually filed suit against Henco to reduce the tax claim to judgment and against the shareholders as transferees. Henco, having formally dissolved in 2012, did not appear and a default judgment was entered against it by the district court for the amount of its unpaid tax, penalties and interest in 2019. A judgment on a tax claim extends the statute of limitations on collection pretty much indefinitely, see post here, giving the government further time to hunt for a way to collect on its tax debt. (This is how the United States was able to try to collect from Al Capone decades after his death.) In this case, the hunt extended to the shareholders who received the proceeds from the sale of the assets, as the suit filed by the United States sought to recover the debt from those assets based on the Georgia fraudulent conveyance statute in effect at the time of the transaction.

The shareholders moved to dismiss the complaint against them, arguing that the Georgia statute of limitations for a fraudulent conveyance suit was only four years, a period that had run long before the suit was filed (given that the essentially defunct Henco spent years dragging out the audit and collection due process cases). The defendants also argued that the only way to recover from a transfer to them was through the use of IRC § 6901, the transferee liability statute, and the statute of limitations on assessment under Section 6901 had also run. The district court agreed that the suit against the shareholders should be dismissed, holding that an assessment had to be made against the transferee in order to collect from the transferee, and that Congress did not intend for the period in which an assessment could be made by a transferee to extend ten years or more.

With the United States once again holding an empty bag, it appealed to the Eleventh Circuit. The Appeals Court easily resolved the issue of the state statute of limitations binding the United States, noting that it has long been held that the federal government does not become subject to a state statute of limitations when it is acting in its governmental capacity and asserting a claim under its rights as the federal government. Turning to the main issue in the case – whether an assessment against the shareholder/defendants was necessary in order to proceed against them, the Eleventh Circuit relied on the Supreme Court case of Leighton v. United States, 289 US 506 (1933) to reject the shareholders’ position. In Leighton, the Supreme Court discussed the predecessor to Section 6901, Section 280 of the Revenue Act of 1926, and noted that prior to the enactment of the predecessor to Section 280, the United States could proceed in an equity proceeding against transferees to recover from assets transferred by the taxpayer. Addressing the question of whether Congress had made Section 280 an exclusive remedy for recovery, requiring an assessment under the transferee procedures of Section 280, the Supreme Court noted that while the meaning of Section 280 was not without uncertainty, “the right of the United States to proceed against transferees by suit since the act of 1926 has been definitely recognized.” The Leighton court concluded that an assessment under Section 280 was not necessary to collect from transferees.

In Henco, the Eleventh Circuit reached the same conclusion, stating that the language of Section 6901 was nearly identical to the provisions of Section 280 of the Revenue Act of 1926. In addition to holding that the procedures under Section 6901 are not the exclusive means of collecting from transferees, the Henco court further supported its position with the case of United States v. Galletti, 541 US 114 (2004), which addressed the question of whether partners in a partnership had to be individually assessed for the United States to recover a tax debt owed by the partnership from the partners. In Galletti, the Supreme Court held that separate assessments were not required, as “it is the tax that is assessed, not the taxpayer.” Holding that it was bound by both Leighton and Galletti, the Eleventh Circuit stated that it was undisputed that there was a timely assessment made against Henco, and that the United States could attempt to collect from the shareholders as transferees of the taxpayer under the relevant state law.

This is not the end of this saga, however, as the Eleventh Circuit merely reversed the dismissal of the shareholder/defendants and remanded the case to the district court for further proceedings. The United States must still prove that the shareholders are transferees liable under the Georgia statute in effect at the time of the transaction, now more than two decades ago. Then, the United States must hope the shareholders still have the money and didn’t lose it in the great recession, the pandemic downturn or just having a good time. Given the propensity of these defendants to drag things out, at the end of all this, the United States may still be left with an empty bag.

Comments

  1. Robert Kantowitz says

    Another instance where bad facts make bad law and where old cases might need to be re-examined.

    1. If a closely held entity sells all of its assets, distributes all the cash and never pays tax on the gains, what do the shareholder-transferees expect? (Maybe even the same if the taxpayer is one of those “midco” entities that were popular and where there was an opinion of counsel that no one had to pay tax; knowing the purpose of the transaction, the controlling shareholders would know that there was risk.)

    Now, change the facts a bit. Suppose that the corporation had a good faith belief as to the amount of tax due, and duly reserved for it and paid it, and the government asserted rather later that it was more. Maybe there was some question as to taxability of income, or maybe the corporation thought it had NOLs that the government later disallowed. Or suppose that the corporation was widely held and the transferees in question had nothing to do with the planning or liquidation. Quite apart from whether the government could eventually get a court to hold the transferees liable under fraudulent conveyance statutes or otherwise “in equity,” a good case — in equity — can be made that such transferees should have the benefit of a normal and reasonable statute of limitations.

    2. The Supreme Court opinion in the Leighton case was short and conclusory with no explanation. The Ninth Circuit’s opinion had pretty much addressed the taxes due as one would address a trust fund, which is decidedly not the way we currently think of entity taxes. The area is due for another look.

    3. By the way, the link in the post is to a different, irrelevant Leighton case.

  2. Elliot Silverman says

    If this case was correctly decided, what is the purpose of section 6901? It now seems totally redundant.

    • @Elliot: section 6901 permits the IRS to proceed administratively. Without it, the IRS would always need to write a beg letter to DOJ asking DOJ to file suit and the the government would need to win the suit before being able to collect. As Marilyn points out, that can take a really, really long time. Even with Collection Delay Process, administrative assessment and collection will be quicker and cheaper. That’s the purpose of 6901. Hope that helps.

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