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.


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.


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.


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.


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?


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.


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.

  • 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).


Summary Opinions for 8/31/15 to 9/11/15

Before jumping into the tax procedure, I wanted to highlight a blog post by another Professor Fogg, Dr. Kevin Fogg, of the University of Oxford.  Kevin Fogg is to the History of Islam in Southeast Asia what our Keith Fogg is to tax procedure (not surprising, since Keith is Kevin’s father).  On September 24th, Kevin wrote a post about the passing of Adnan Buyung Nasution.  From the post, I learned that he gave much to Indonesian life, including the founding of a legal aid organization for those in Indonesian in need of legal assistance.  The post is brief, and gives a glimpse into the life of a great man who I knew nothing about.  Absolutely worth your time.

To the tax procedure (heavy on estate and gift this week):

  • We’ll start with a heavily redacted FSA discussing what constitutes adequate disclosure to avoid the extended and unlimited statute of limitations under Section 6501(c)(9) for gift purposes.  See LAFA 20152201F.  Usually, a gift has to be disclosure on a timely filed Form 709 (due April 15 the following year), which then starts a three year statute of limitations.  There is an exception when a gift is not shown or appropriately disclosed.  When there is inadequate disclosure, the IRS has unlimited time for assessment.  When this is the case, the gift can be brought up decades later upon the audit of the Form 706 for the taxpayer’s estate after death.  To adequately disclose, the taxpayer must provide sufficient information to  “apprise [the Service] of the nature” of the gift.   The Regulations flesh out what the IRS thinks is required:

(i) A description of the transferred property and any consideration received by the transferor; (ii) The identity of, and relationship between, the transferor and each transferee; … (iv) A detailed description of the method used to determine the fair market value of property transferred, including any financial data (for example, balance sheets, etc. with explanations of any adjustments) that were utilized in determining the value of the interest, any restrictions on the transferred property that were considered in determining the fair market value of the property, and a description of any discounts, such as discounts for blockage, minority or fractional interests, and lack of marketability, claimed in valuing the property . . . .In addition, if the value of the entity or of the interests in the entity is properly determined based on the net value of the assets held by the entity, a statement must be provided regarding the fair market value of 100 percent of the entity (determined without regard to any discounts in valuing the entity or any assets owned by the entity), the pro rata portion of the entity subject to the transfer, and the fair market value of the transferred interest as reported on the return. . .

See Reg. 301.6501(c)-1(f)(2).

Surprisingly, there is not much case law or other guidance on what is actually adequate disclosure.  The LAFA highlights two cases, Sanders and Lewis, but neither actually has much of a discussion.  Both were motions for summary judgement, and the Courts found there was a material question about the adequate disclosure, causing the motions to be dismissed without any concrete takeaways.  There was Chief Counsel Advice issued in 2002 discussing the statute in the transfer of closely held LLC interests.  The advice indicated inadequate disclosure had occurred where the taxpayer failed to specify the number of units transferred, the percentage ownership interest transferred, and the nature of the interests.  Interestingly, in that advice, Chief Counsel referenced the income tax regulations extending the statute of limitations for understatements of income, and the fact that a “clue” may be sufficient to cut off the statute.    Later in the advice, it did indicate that more than a “clue” would likely be required for proper disclosure.

Back to the LAFA, in which it was concluded that insufficient disclosure occurred.  On a 709, the taxpayer disclosed the transfer of an LP interest and an LLP interest to the taxpayer’s daughter.  It disclosed the name, percentage and value.  One of the EINs for the entity was incorrectly stated (missing one digit), and the “LP” and “LLP” were both left off the name of the entities.  The LAFA indicates these by themselves are fatal, and could result in an unlimited statute of limitations.  I disagree with this determination and would be inclined to take this before a judge.  The LAFA indicates there were 70 possible different EINs that could have resulted because of the missing digit.  I have to assume the Service has a searchable database, and could quickly have used the disclosed name to determine the  correct one.  That error by the preparer should not result in unlimited statute of limitations.

The advice also indicates the valuation was not adequately disclosed, resulting in the statute remaining open.  In the summary attached to the return, it was not explicitly stated how the valuation was done, no financial information was provided to back up the valuation, the discount percentages were not explained, and it appeared that additional, unspecified discounts were taken.  I would like to see the actual statement, not the redacted version.  A fair amount of disclosure was made, including that a valuation of the underlying property was done, which would implicate net asset value was used in the valuation.  Although the LAFA makes it seem unclear as to how the discounts were taken, my view might be different when reviewing the return as a whole.  In any event, the LAFA provides guidance on what the IRS might consider worth litigating, and should be considered in preparing summaries of gifts or attaching the appraisals.

  • In the end of August, the IRS announced it would abate penalties for missing or incorrect TINs for colleges and universities that filed Form 1098-T with the incorrect information for 2012 to 2014.  Under Section 6721, a penalty is imposed for each information return that is not filed or filed with incorrect or incomplete information.  For 2015, Section 6724(f) was modified to provide prospective relief for educational institutions that fail to include the TIN, if the organization attempted to obtain the information but was not able to obtain the information.  The change was not retroactive, but the IRS has decided to waive the prior penalties.  The notice indicates the IRS will contact the schools, but those who are not contacted should respond to the original penalty assessment notice.  No guidance is provided for those who already responded to the original penalty assessment.  In those cases, the institutions will have to contact the Service to make a refund claim.  It is possible some of those could be approaching the statute of limitations for the refund.
  • In the last SumOp we touched on the new opinion issued in the Marshall case from the Fifth Circuit holding the maximum amount of gift tax, penalties and interest that could be collected from the donee was the value of the initial gift under Section 6324(b) (reversing its prior holding).  It is also worth noting that the Fifth Circuit upheld the lower court’s holding that the executor of Mr. Marshall’s estate and trustees of related trusts were personally liable for the outstanding gift tax debt because they paid other creditors, set aside funds for charity, distributed personal property, paid rent on a vacant apartment, and paid for accounting and legal services of other entities instead of paying the government.  The Court held that 31 USC § 3713, the Federal Priority Statute, applied, because each fiduciary knew about the possible debts, although the fiduciaries argued they did not have actual knowledge.  The Court determined “notice of such facts as would put a reasonably prudent person on inquiry as to the existence of the unpaid claim” was found (and the fiduciaries essentially stated as much).  Marshall predominately dealt with transferee liability under Section 6901(a)(1)(A), but 31 USC § 3713 is incorporated by reference under Section 6901(a)(1)(B), and states a fiduciary is liable for the estate and gift taxes if distributions were made in a manner contrary to 31 USC § 3713.  I’m sure those involved are not happy with the result, but it has been a great gift tax procedure case.
  • Also in last week’s SumOp, we touched on the Minnick case, where the Ninth Circuit held that a taxpayer was not entitled to a conservation easement because the mortgage on the donated property was not properly subordinated.  Reader Scott Davies commented, indicating that oral argument of that case was available on YouTube.  You can read the comment here, which has the video imbedded.
  • The District Court for the Middle District of Georgia issued an order on two motions in the case Dickerson v. Suntrust Banks, Inc. which was somewhat unique.  The Court allowed the defendant bank’s motion to amend its pleading to properly add the United States (instead of the IRS), but also granted the United States’ motion to dismiss it from the action.  In the case, the taxpayer plaintiffs filed suit against the bank defendant alleging breach of contract, conversion, intentional infliction of emotional distress, violations of the GA fair business practices act and RICO statute, and, my favorite, wrongful dishonor (all I envision for this is an angry button-down father chasing a young man from his house).  The claims arose from the bank defendant’s closing of taxpayer’s account after being informed by the IRS that the accounts held erroneous tax refunds from numerous other taxpayers.  A portion of the funds were remitted to the IRS.

The bank defendant alleged that it took these actions based on an indemnification agreement it entered into with the IRS, which stated the IRS would repay the bank defendant for any payments it had to make to the taxpayer later based on the funds remitted to the IRS.  When the bank was served, it in turn filed a third party complaint against the IRS indicating it was entitled to the indemnification.  The government filed a motion to dismiss, arguing it had not waived sovereign immunity.

The bank argued that under The Little Tucker Act, 28 USC 1346, the Court had jurisdiction, because it was a civil claim against the US for over $10,000 based on a contract.  The Court found that there could have been a contract, and the Tiny Tuck could provide jurisdiction, but the bank did not allege any violation of the agreement.   Since there was no alleged violation, the Little Tucker Act did not provide jurisdiction.  I wonder if counsel for the bank had tried to include that the IRS had to defend any related claim.

  • From Jack Townsend’s Federal Tax Crimes blog, a post highlighting how to ensure conferences are obtained in criminal tax matters with the IRS and DOJ before indictments in criminal matters.
  • Around this time last year in SumOp, we covered the Tax Court case Law Office of John Eggersten v. Commissioner, where the Tax Court reversed its prior holding and held the general statute of limitations under Section 6501 (unlimited because no return was filed) applied to the assessment of ESOP excise tax.  The Service argued the statute of limitations under Section 4979A(e)(2)(D) supplemented, but did not replace the general statute.  The Sixth Circuit, in a split decision, has affirmed the tax court.  The quick and dirty is that the law firm and the ESOP that owned the stock in the law firm each filed the required income tax returns.  Due to some changes in the law, which the ESOP didn’t fully comply with, it also needed to file a Form 5330.  The Sixth Circuit determined the information filed on the other returns was not sufficient for the Service to calculate the tax due that should have been reflected on the Form 5330.  The taxpayer argued that although that was the case, it provided sufficient information on its returns to meet the requirement under Section 4979A that the limitations period begins with “the filing of a return…on which an entry has been made with respect” to the tax.  See Section 6501(b)(4).  The Court held that exception only applies if the information is reported on a return for which the tax should be reported, which was the return the taxpayer failed to file.



Transferee Liability When Selling a Corporation

We welcome back guest blogger Marilyn Ames who writes about an important recent 9th Circuit opinion reversing and remanding a Tax Court decision regarding the proper standard to apply in transferee liability cases.  Marilyn, a Chief Counsel retiree and current resident of Alaska, is working with me to revise and update Chapter 17 of Saltzman and Book on transferee, trust fund and other derivative tax liability issues.  Keith

In its second opinion on the issue of transferee liability issued within a year, the Ninth Circuit recently took the Tax Court to task in the case of Slone v. Commissioner, 2015 WL 5061315 (August 28, 2015), and remanded the case, instructing the Tax Court to use the correct legal standard in applying Section 6901 of the Internal Revenue Code to the transaction in question.  In doing so, the Ninth Circuit expanded the analysis to be used in determining when a person is liable as a transferee, which it first set out as a two-prong test a year earlier in Salus Mundi Foundation v. Commissioner, 776 F.3d 1010 (9th Cir. 2014). In the Slone case, the Ninth Circuit recognized it was breaking new ground, holding: “Although we have not previously considered how a court should analyze a transaction for purposes of transferee liability under § 6901, both the Supreme Court cases, and our own precedent, require us to look through the form of a transaction to consider its substance.”


In order to understand the breadth of the Ninth Circuit’s holding, a review of the facts in the Slone case is necessary. The facts in Slone are not simple.  Slone Broadcasting Co. sold all its assets to Citadel Broadcasting Co. for $45 million. Before this transaction closed, Fortrend International, LLC approached the shareholders of Slone and suggested a merger with Slone Broadcasting, with an alleged eye to restructuring the resulting company to engage in asset recovery. The shareholders agreed, and after the asset sale, sold their shares of Slone to Berlinetta, Inc., an affliate of Fortrend, for $35.8 million.   At this point, Slone no longer had its radio broadcasting network, but did have a lot of cash and a tax liability of about $15 million from the sale of its assets. Berlinetta agreed to assume Slone’s income tax liability, and the Slone shareholders received cash payments for their stock totaling $33.6 million.

Slone then merged with Berlinetta, and the remaining company changed its name to Arizona Media Holdings Inc. Within days of the sale of the stock, an unnamed shareholder of the new Arizona Media contributed Treasury bills with a basis of $38.1 million to the new company.  Arizona Media then sold the bills for $108,731.  When Arizona Media filed its tax return for this fiscal year, it reported a $37.9 million gain from the sale of Slone’s assets, claimed a loss of $38 million from the Treasury bill sale, and no tax liability.  It then requested a refund of the $3.1 million tax payment previously made by Slone, which the IRS granted.

Once the IRS took a closer look at Arizona Media’s return, it was not so agreeable.  Eventually, the Service assessed a deficiency against Arizona Media in the amount of $13.5 million, along with interest and penalties.  Arizona Media paid nothing towards this liability, and the next year the state of Arizona dissolved Arizona Media for failing to file its annual report.  Once again, the IRS was not happy and looked around for another party to tap for the unpaid bill.  Using Section 6901, the IRS determined that the shareholders were liable as “transferees” of Slone, taking the position that the substance of the transactions was that Slone dissolved when it sold its assets to Citadel, and the remaining assets – consisting of the cash from the asset sale – were then distributed to the shareholders through the transaction put together by Fortrend. According to the Commissioner, the Slone shareholders were transferees as they received the assets of a taxpayer who owes income tax. The Tax Court disagreed with the Commissioner, holding that it would respect the form of the transactions, so the shareholders were not the transferees of Slone.  The Service was again unhappy, and appealed to the Ninth Circuit.

It was here that the Commissioner got some limited satisfaction.  The Ninth Circuit found that the Tax Court had applied an incorrect legal standard in characterizing the transaction for tax purposes. The Court, at length, instructs the Tax Court on the standard it should have applied, holding that determining whether a person is a transferee requires a two-prong inquiry.  The first prong requires an analysis of federal law to determine if the person is a transferee under Section 6901 and federal tax law.  The second prong of the test requires an analysis of whether the person is substantively liable for the transferor’s unpaid taxes under applicable state law because of the receipt of the transferor’s property, using the state’s fraudulent conveyance law.  The two prongs are separate and independent inquiries, according to the Ninth Circuit.

The Ninth Circuit’s focus in Slone is on the first prong, with a new emphasis on looking at what a transaction actually is.  Citing Frank Lyon Co. v. United States, 435 U.S. 561 (1978), and Casebeer v. Commissioner, 909 F.2d 1360 (9th Cir. 1990), the Ninth Court outlines another two-part test for determining whether a transaction is a sham: was there a business purpose for the transaction, and has the taxpayer shown the transaction had economic substance beyond the creation of tax benefits? Although the Ninth Circuit outlines a two-step test, which should consider both subjective and objective factors, the Court suggests a “holistic” analysis rather than a rigid application of the two steps.  In other words “If a common sense review of the transaction leads to the conclusion that a particular transaction does not have a non-tax business purpose or ‘any economic substance other than creation of tax benefits,’ the form of that transaction may be disregarded, and the Commissioner may rely on its underlying economic substance for tax purposes” (citing Reddam v. Commissioner, 755 F.3d 1051 (9th Cir. 2014)).

Using this newly articulated standard, the Ninth Circuit concludes that the factors the Tax Court looked at in reaching its decision were not relevant to determining whether the transactions in question had a “business purpose . . .other than tax avoidance, or whether the stock purchase transaction had economic substance other than shielding the Slone Broadcasting shareholders from tax liability.” The Tax Court’s findings were, the Court opined, factors that related to the question of whether the shareholders had knowledge that would make the transaction fraudulent under state law.  And so the Ninth Circuit sent the Slone cases back to the Tax Court to apply the correct legal standard.

Whether the IRS will be happy at the end of the day remains to be seen.  Although the Tax Court may not have applied the correct factors in reaching a conclusion as to the first prong, the Tax Court did make factual findings that would support a negative conclusion that the Slone shareholders had acted fraudulently under state law, the second prong of the test to impose transferee liability under Section 6901.  Since both prongs must be met to impose liability, the Commissioner may simply have won one battle, the overall impact of which remains to be seen.