The U.S. Tax Court has ruled that shareholders in a C corporation who had transferred all of the corporation’s cash to a third party, without paying corporate taxes on a land sale, were liable for the unpaid taxes. Sounds bad, right? Not completely: The court also found that, under applicable state law, they were liable only for the amount of benefit they received from the transfer.
The corporation sold land it owned in Nebraska to the city of Lincoln for about $471,000 in June 2003. After the sale, the corporation’s only asset was cash.
While in negotiations with the city, the shareholders were contacted by a company offering to buy their shares in exchange for the corporation’s cash on hand. It would pay the value of the cash, less an amount representing about two-thirds of the corporation’s estimated tax liability. The deal would leave the shareholders with more money than they’d receive if they simply dissolved the company and received the land sale proceeds in redemption of their shares.
The parties executed a sales agreement in August 2003. As part of the transaction, the corporation transferred its cash on hand to the purchaser’s attorney’s trust account the day before closing. The next day, the attorney distributed the cash to an account in the name of the corporation and, the following day, to an account held by the purchaser.
The sales agreement between the purchaser and the shareholders provided that the purchaser would pay all taxes due for 2003, but the purchaser failed to do so. The IRS subsequently determined a deficiency of $145,923 (plus about $58,000 in penalties) in the corporation’s federal income tax and sued the shareholders for the unpaid taxes.
Section 6901 of the Internal Revenue Code authorizes the IRS to proceed against the transferees of delinquent taxpayers to collect unpaid taxes. To do so, though, the agency must first establish that:
- The transferee is liable for the transferor’s debt under the applicable state or federal law and
- The target is a “transferee.”
The Tax Court found that the transfer of the corporation’s cash to the attorney’s trust account was fraudulent with respect to creditors under Nebraska’s Uniform Fraudulent Transfer Act (which has been adopted by most states) because the corporation didn’t receive “reasonably equivalent value” in exchange for it and the transferor (the corporation) became insolvent as a result of the transfer. Because the shareholders benefited from the transfer, they were liable to the IRS, which was a creditor of the corporation. And because they were liable to the IRS, the court said, they were transferees under Section 6901.
Despite its finding that the IRS could pursue the shareholders for the corporation’s unpaid taxes, the court didn’t award the IRS the approximately $204,000 it sought. Instead, the court found that the shareholders were collectively liable for only the benefit they received from the transfer — the difference between the after-tax amount they would have received if they’d liquidated the corporation (and paid the taxes) and the amount they received in the sale for their shares. That amount came to about $59,000, so the shareholders ultimately paid substantially less than the unpaid taxes due.