The United States Tax Court recently ruled that shareholders of a Nebraska corporation are liable for their share of the corporation’s unpaid taxes. See William Scott Stuart v. Commissioner, 144 T.C. No. 12 (2015).
The relevant parties in the case are Little Salt, a Nebraska C corporation, and MidCoast Investments (MidCoast). In June of 2003, Little Salt sold 160 acres of land to the city of Lincoln, Nebraska, generating $432,148 of gain. After the sale, Little Salt’s only asset was cash. Prior to the sale, in April 2003, Little Salt shareholders received an offer from MidCoast to purchase all of Little Salt’s outstanding shares at a price equal to all of the cash held by Little Salt reduced by a portion of Little Salt’s tax liabilities. MidCoast covenanted to file Little Salt’s tax returns and pay a portion of its taxes. The parties executed the transaction in early August 2003. Little Salt transferred all of its cash to MidCoast and MidCoast transferred to Little Salt’s shareholders an amount equal to the cash received, minus an approximation of Little Salt’s tax liability. After MidCoast received the cash from Little Salt, it then transferred the cash to a Little Salt account. The cash was then transferred back to a MidCoast account and Little Salt recorded the latter transfer as a receivable due from the shareholder.
In December 2003, Little Salt filed its 2003 tax return and reported taxable income of $432,148 and tax due of $148,456. Little Salt did not pay the tax and in February 2005, Little Salt filed its 2004 tax return and reported a bad debt deduction of $450,370 from the worthlessness of the shareholder loan. The deduction created an NOL that Little Salt carried back to 2003. The respondent examined Little Salt’s 2003 and 2004 tax returns, disallowed the 2004 bad debt deduction and the 2003 NOL, assessing a tax deficiency and penalties. After the IRS failed to collect on the amounts assessed, it sent notices to the Little Salt shareholders concluding that they were transferees of Little Salt’s assets and liable for the 2003 unpaid tax.
Section 6901 allows the IRS to collect unpaid taxes from transferees of the transferor taxpayer’s property. The statute does not exhaustively define “transferee” other than to say the term includes “donee, heir, legatee, devisee and distributee.” The most common form of transferee liability is transferee in equity, which arises when a transferee receives the transferor’s assets for less than adequate consideration, leaving the transferor unable to pay its tax liability. Transferee in equity cases are typically based on state fraudulent conveyance law.
The IRS, as it has in the past, argued that the court should use federal tax doctrine to disregard the form of the transaction and decide, based on the substance of the transaction, that the Little Salt shareholders were transferees under section 6901. The IRS argued that the transaction was essentially a liquidating distribution of cash to the Little Salt shareholders in exchange for their shares, followed by a payment by the shareholders to MidCoast as compensation for participating in the transaction. The court should then apply state law to the re-characterized transaction.
The court rejected the IRS’s two-step approach and instead first established the shareholders’ liability under the Nebraska Uniform Fraudulent Transfer Act (UFTA). The Nebraska UFTA sets forth several tests for determining whether a transfer is fraudulent. Under one test, a fraudulent transfer occurs if a creditor’s claim arises before the transfer, the transferor does not receive adequate consideration and the transferor became insolvent as a result of the transfer. The court reasoned that the IRS’s tax claim arose prior to the transfer under the relevant law, the value of MidCoast’s covenant to pay Little Salt’s tax liabilities was not reasonably equivalent to the amount that Little Salt transferred to MidCoast, and Little Salt, having transferred all of its assets despite owing tax, became insolvent as a result of the deal. The UFTA further established that judgment could be entered against the Little Salt shareholders because the transfer of Little Salt’s cash to MidCoast was made for the benefit of the shareholders in that the transfer was a prerequisite for MidCoast’s payment to the Little Salt shareholders.
After determining that judgment against Little Salt’s shareholders was proper under the Nebraska UFTA, the court then held that the shareholders were therefore transferees under section 6901 and liable for the uncollected tax.
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