United States: MIDCO Transactions And The Expanding Universe Of Transferee Liability

The Internal Revenue Service's determination of transferee liability, essentially secondary liability, resulting from transactions involving the taxable sale and disposition of corporate stock, is being litigated with increasing frequency in the federal courts. The outcome of these disputes varies as they are highly fact determinative. Thus, not surprisingly, Taxpayers have experienced mixed results in court. Although there are lower courts that have held in favor of the putative transferee, selling shareholders, three recent Tax Court decisions have been reversed on appeal.1 In fact, to date only one taxpayer victory has been affirmed on appeal.2

The IRS's recent successes have emboldened it to utilize transferee liability more frequently as a tax collection mechanism, most notably against corporate shareholders who engaged in so-called Midco or middle-company transactions,3 primarily during the late 1990s to early 2000s.

Generally, a Midco transaction is one in which the seller engages in a stock sale (thus avoiding the triggering of built-in gain in appreciated assets) while the buyer engages in an asset purchase (thus allowing a purchase price basis in the assets), through use of an intermediary company. Taxpayers involved in these Midco transactions, and taxpayers who may be contemplating transactions that could be construed as Midcos, should be cognizant of their potential exposure as transferees under Code section 6901.4 They could potentially be subject to liability for their counterparty's unpaid taxes, interest and potential penalties related to the disposition of the property. Generally, the salient issue in these Midco transferee cases is whether the selling shareholder knew or should have known that the Midco intermediary would incur a tax liability that it could not and would not pay and thus would not be collected. Practitioners should be forewarned consequently that it would be prudent to give appropriate consideration to Section 6901 and evaluate their client's potential exposure to transferee liability before the transaction is completed. Part I of this paper evaluates Section 6901 on several fronts, with particular emphasis on recent decisions involving Midco transactions. Part II of this paper considers whether there are any limitations or defenses to the statute's reach. Since transferee liability of a taxpayer is derived from statutory authority, it is proper to begin by looking at the Code.

Legislative History of Section 6901 and Transferee Liability

In 1926, as part of an effort to assist in the collection of taxes, Congress enacted a provision that enabled the United States for the first time to proceed against those secondarily liable in the same manner as against those primarily liable.5 The purpose of Section 280 was to provide a summary and expeditious method of collecting income taxes in situations in which a taxpayer disposed of his assets, leaving himself unable to meet his tax liability. Prior thereto, the only avenue of redress open to the Government in such a case was to proceed against the transferee in equity upon a trust fund theory or at law if the debts of the transferor had been assumed. However, in practice, this was difficult and expensive, and was seldom attempted. Consequently, Congress established the alternative summary method of collection by notice to the transferee and extended to the taxpayer the opportunity either to pay and sue for a refund, or else to proceed before the Tax Court.6 No new obligation was created by the statute against the transferee, but merely a new procedure for enforcing the existing tax liability.7 Section 280 followed the enactment of Section 209 of Act of Congress in 1916, which created a liability at law for certain transferees of estates.8 A similar provision was subsequently enacted in 1932 for gift taxes.9

Section 311 of the Internal Revenue Code of 1939 followed as the successor to Section 280.10 The courts also recognized that Section 311 neither created nor defined a substantive  liability but provided merely a new procedure by which the Government may collect taxes.11 The U.S. Supreme Court has long since confirmed that this section "neither creates nor defines a substantive liability but provides merely a new procedure by which the Government may collect taxes."12

In 1954, the collection provisions for transferee liability in the areas of income, estate and gift taxes were collapsed into the current version of Section 6901.13 Section 6901(a) provides that the liability of a transferee of a taxpayer's property may 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 in the case of income, estate and gift taxes.14 In other words, "Section 6901 allows the IRS to assess and collect from the transferee the tax liability of the transferor as though the transferee was the taxpayer."15 A "transferee" includes a "donee, heir, legatee, devisee, [or] distributee."16 Transferee liability under Section 6901 does not create a separate or new liability – it merely provides the IRS with a secondary method for collecting the transferor's tax liability.17

Although the language adopted in Section 6901 differs from that used in the earlier versions, the intent and purpose of the underlying collection provision of transferee liability remained unchanged. The legislative history that accompanied the progeny of Section 6901 indicated that the new collection procedure was intended to be a "substitute for" the trust fund equitable proceedings.18 But some courts interpreted the provision as providing an alternate method of enforcing a transferee's obligation.19 Regardless of which interpretation is correct, the enactment of Section 6901 did not change the extent of the transferee's liability under existing law.20 The Conference Report to Section 280 stated that "(w)ithout in any way changing the extent of such liability of the transferee under existing law, the amendment enforces such liability . . . in the same manner as the liability for a tax deficiency is enforced."21 It is also important to note that Section 6901 is strictly procedural in nature, it does not grant the Government any substantial rights.22

For nearly thirty years following the passage of Section 280, courts and taxpayers struggled with the issue whether the transferee liability Code provision should be determined by reference to federal law or state fraudulent conveyance law. In 1958, the Supreme Court settled the debate in Commissioner v. Stern.23 In Stern, the Supreme Court ruled that transferee liability must be determined by reference to state law. The Supreme Court recognized that the procedures in place prior to the enactment of Section 6901's predecessor statute "proved unduly cumbersome."24 The statute was enacted in order to do away with the procedural differences between collecting taxes from one who was originally liable and from someone who received property from the original tax owner.25 The statute was not enacted to expand the Government's reach as creditor in collecting taxes. Rather, the Supreme Court recognized that "[t]he Government's substantive rights in this case are precisely those which other creditors would have under [state] law."26 As such, Section 6901 was never intended to place the Government in a better position than any other creditor under state law. Thus, the existence and extent of the transferee's liability are determined by the law of the State in which the transfer occurred.27

In Tax Court, the Commissioner bears the burden of proving that a taxpayer is liable as a transferee.28 To successfully assert transferee liability, the IRS must both identify a substantive basis (state law) beyond Section 6901 and assert liability via the procedures mandated by Section 6901. The IRS may assess transferee liability under Section 6901 against a party only if two distinct prongs are met: (1) the party must be a transferee under Section 6901; and (2) the party must be subject to liability at law or in equity.29 Under the first prong of Section 6901, the court will look to federal tax law to determine whether the party in question is a transferee.30 The second prong, whether the party is subject to liability at law or in equity, is determined by the applicable state law.31 If there is no "conveyance" under state law, then there is no need to determine whether the taxpayer is a transferee under federal law.32 Because transferee liability rests on the principle of equity, nexus to the transaction is paramount to secondary collection against a transferee. A transferee can also be liable for interest33 and penalties.34

To read this paper in full, please click here

Footnotes

1 See Diebold Foundation, Inc. v. Commissioner, 736 F.3d 172 (2d Cir. 2013); Frank Sawyer Trust v. Commissioner, 712 F.3d 597 (1st Cir. 2013); Slone v. Commissioner, 778 F.3d 1049, modified 116 AFTR2d 2015- 5962 (9th Cir. 2015).

2 See Starnes v. Commissioner, 680 F.3d 417 (4th Cir. 2013).

3 See Notice 2001-16.

4 Unless otherwise indicated, all references in this article to "Section" and "Sections" are to the Internal Revenue Code of 1986, as amended (the "Code"), and all references to "Treas. Reg. §" are to regulations issued thereunder (the "Treasury Regulations" or "Regulations"). Reference to the "IRS" or "Service" are to the Internal Revenue Service.

5 See Section 280 of the Revenue Act of 1926.

6 The summary transferee liability procedures of Section 6901 do not replace the trust fund doctrine or other federal statutes, such as the Federal Debt Collection Procedures Act of 1990.

7 See Hatch v. Morosco, 50 F.2d 138 (2d Cir. 1931).

8 See Ch. 463, S 209, 39 stat. 756, 780 (1916). The provisions of Section 280 of the Revenue Act of 1926, providing the new remedy for collection of income taxes, are almost identical to the provisions applicable to estates. See Section 6324. In the context of estate taxes, a transferee's personal liability is derived from Section 6324(a)(2) which provides, "(i)f the estate tax imposed by chapter 11 is not paid when due, then the . . . transferee . . . or beneficiary, who receives, or has on the date of the decedent's death, property included in the gross estate under sections 2034 to 2042, inclusive, to the extent of the value, at the time of the decedent's death, of such property, shall be personally liable for such tax." The "value" of the property is its fair market value.

9 See Ch. 209, S 510, 47 stat. 245, 249-501 (1932). In the context of gift taxes, if a donor fails to pay his annual gift tax liability the second sentence of Section 6324(b) provides that "the donee of any gift shall be personally liable for such tax to the extent of the value of such gift" as of the time the gift was completed. The "value" of a gift is the fair market value of the property received from the donor. In addition to the personal liability of the transferee, the liability is also secured by a lien on the property received.

10 Section 311 of the Internal Revenue Code of 1939 provided, in part:

(a) Method of collection. The amounts of the following liabilities shall, except as hereinafter in this section provided, be assessed, collected, and paid in the same manner and subject to the same provisions and limitations as in the case of a deficiency in a tax imposed by the chapter (including the provisions in case of delinquency in payment after notice and demand, the provisions authorizing distraint and proceedings in court for collection, and the provisions prohibiting claims and suits for refunds):

(1) Transferees. The liability, at law or in equity, of a transferee of property of a taxpayer, in respect of the tax (including interest, additional amounts, and additions to the tax provided by law) imposed upon the taxpayer by this chapter.

(f) Definition of 'transferee'. As used in this section, the term 'transferee' includes heir, legatee, devisee, and distributee.

11 See e.g., Phillips v. Commissioner, 283 U.S. 589 (1931); Hatch v. Morosco, 50 F.2d 138 (2d Cir. 1931); Weil v. Commissioner, 91 F.2d 944 (2d Cir. 1937); Tooley v. Commissioner, 121 F.2d 350 (9th Cir. 1941).

12 Commissioner v. Stern, 357 U.S. 39, 42 (1958) (discussing the predecessor transferee liability statute under the Internal Revenue Code of 1939, 26 U.S.C. § 311).

13 In 1954, legislative history indicates that the amalgamation of the three separate provisions into a single section was not intended to change existing law. See S. Rep. No. 1622, 83rd Cong., 2 Sess., reprinted in 1954 U.S.C.C.A.N. 4793, 5225.

14 Section 6901(a) provides:

(a) Method of Collection – The amounts of the forgoing liabilities shall, except as hereinafter in this section, 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:

a. (1) Income, Estate, and Gift Taxes – (A) Transferees – The liability, at law or in equity, of a transferee of property –

(i) of a taxpayer in the case of [income] tax.

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

15 See William W. Han, The Scope of Transferee Liability in Estate and Gift Tax Cases, TAXES (Jan. 1, 1996).

16 See Section 6901(h).

17 The trust fund doctrine is another legal theory utilized by the IRS to collect tax from a transferee. The doctrine has been sparingly invoked by the IRS since the enactment of Section 6901 and is beyond the scope of this article.

18 See H.R. Conf. Rep. No. 356, 69th Cong. 1st Sess. (1926), reprinted in 1939-1 C.B. (Part 2) 361, 372.

19 See Phillips v. Commissioner, 283 U.S. 589 (1931); United States v. Geniviva, 16 F.3d 522 (3d Cir. 1994).

20 See H.R. Rep. No. 356, 69th Cong., 1st Sess. (1926), reprinted in 1939-1 C.B. (Part 2), 361, 371.

21 Id.

22 See Starnes v. Commissioner, 680 F.3d 417 (4th Cir. 2012).

23 357 U.S. 39 (1958)

24 Id. at 43.

25 Id. at 43; John Ownbey Co. v. Commissioner, 645 F.2d 540, 543 (6th Cir. 1981), citing Delia v. Commissioner, 362 F.2d. 400, 402 (6th Cir. 1966)

26 Id. at 47.

27 Id. at 45.

28 See Section 6902(a); Tax Court Rule 142(d). However, in a tax refund suit, the taxpayer bears the burden to show that plaintiff is not liable as a transferee. See e.g. Andrew v. United States, 91 F.Supp.3d 739 (D NC 2015).

29 See Rowen v. Commissioner, 215 F.2d 641, 643 (2d Cir. 1954) (discussing predecessor statute, 26 U.S.C. § 311).

30 Id. at 644.

31 See Stern, 357 U.S. at 45. In Stern, the Government argued, unsuccessfully, that the court reject the applicability of state law in favor of having the federal courts fashion a unified federal rule to determine transferee liability. Since Stern, the First and the Fourth Circuits have both addressed the relationship between the transferee prong and the liability prong of Section 6901. Both of these circuits concluded that the two prongs of Section 6901 are independent, and that the Tax Court did not err by only addressing the liability prong under state law. See Frank Sawyer Trust of May 1992 v. Commissioner, 712 F.3d 597, 605 ( 1st Cir. 2013); Starnes v. Commissioner, 680 F.3d 417, 428 (4th Cir. 2012). The Second Circuit recently joined the First and Fourth Circuits in their interpretation of Section 6901. See Diebold Foundation, Inc. v. Commissioner, 736 F.3d 172 (2d. Cir. 2013).

32 See Frank Sawyer Trust of May 1992 v. Commissioner, 712 F.3d 597, 605 (1st Cir. 2013)("if the Trust was not a transferee of the companies for purposes of Massachusetts fraudulent transfer law, then whether or not it was a 'transferee' for purposes of Section 6901 is irrelevant.")

33 In Stein v. Commissioner, the Tax Court stated that federal law governs the running of interest when the value of the transferred assets exceeds the transferor's total liability. 37 T.C. 945, 961 (1962). ("In cases where the transferred assets exceed the total liability of the transferor, the interest being charged is upon the deficiency, and is therefore a right created by the Internal Revenue Code.") The Code provides that the transferee is liable for interest from the date of the fraudulent transfer. See Section 6601; Lowy v. Commissioner, 35 T.C. 393, 395-96 (1960) ("[W]here the tax liability [is] greatly in excess of the amount received by the transferees in distribution . . . the transferee [is] liable to the full extent of the amounts received by them with interest from 'the fair average date of receiving' the sums distributed."). However, state law governs the running of interest when the value of the transferred assets is "insufficient to satisfy the transferor's tax liabilities." Stein, 37 T.C. at 961. Under New York law, "interest on a conveyance voidable because of constructive fraud runs from the date of demand by the creditor, but where actual fraud exists, interest runs from the date of fraudulent conveyance." Id. at 692 (citing MacIntyre v. State Bank of Albany, 307 N.Y. 630 (1954)).

34 The Code and Treasury Regulations do not explicitly state that transferees shall be liable for penalties. Nevertheless, courts have held that "the Internal Revenue Code . . . spells out the right of the Government to [collect] the so-called penalties" from transferees. Lowy v. Commissioner, 35 T.C. 393, 395 (1960). The courts have reached this conclusion summarily. See, e.g., Mizrahi v. Commissioner, T.C. Memo 1992-200; Swinks v. Commissioner, 51 T.C. 13, 17 (1968). Presumably, they do so by looking to the statutory structure of Section 6901, which provides that the transferee's liabilities "shall . . . be assessed, paid, and collected in the same manner . . . as in the cases of the taxes with respect to which the liabilities were incurred." Subsection (b) adds that "[a]ny liability . . . may be either as to the amount of tax shown on a return or as to any deficiency or underpayment of any tax." Together, these subsections provide that the amount of the transferee's liability is measured "as to any deficiency or underpayment" that created the transferor's liability. See Section 6902. In other words, the transferee steps into the shoes of the transferor. See Saltzman, IRS Practice & Procedure, pt. 17.05 ("Because the amounts of tax, penalty, and interest constitute the claim of the United States against the taxpayer/transferor, they also measure the claim against the transferred assets followed into the hands of the transferee."); see also I.R.M. pt. 4.10.13.3.2.1 (stating that transferee liability should "include liability . . . for penalties").

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions