The Eleventh Circuit affirmed the Tax Court's determination that petitioner was liable as a transferee under 26 U.S.C. 6901 for his former employer's unpaid taxes, in Kardash v. Commissioner of IRS, US Court of Appeals for the Eleventh Circuit, Docket: 16-14254.
The Tax Court had previously found two minority shareholders liable to return several million of dividends they received from a corporation when the corporation failed to pay federal income taxes at the direction of majority shareholders, which majority shareholders also drove the company into insolvency by siphoning off corporate funds.
The minority shareholders were found liable under the Internal Revenue Code transferee liability statute (Code Section 6901). Since the application of that statute is predicated under the applicable state law, the fraudulent conveyance aspects of the case would likewise apply to create similar liabilities for the minority shareholders as to amounts due to creditors by the corporation other than the IRS. Here, the state at issue was Florida.
Besides the somewhat “unfair” result of the minority shareholders suffering for the sins of the bad actor majority shareholders, some other interesting aspects of this case include:
1. The shareholders did not have to return amounts “advanced” to them under a bonus program in years before the corporation became insolvent. Such amounts related to a continuation of a prior bonus compensation plan, that converted to loans when the company was not doing so well. Even those these amounts were initially treated as loans, and then later recast by the IRS as taxable dividends under audit, the Tax Court nonetheless treated them as compensation for services provided. As such, the corporation was treated as having received fair value for its payments, in that circumstance, a fraudulent conveyance does not arise.
2. In trying to force a repayment of the above advances, the IRS also tried to argue that the minority shareholders committed actual fraud in receiving those payments. The Tax Court ran through a “badges of fraud” analysis, and ultimately concluded that there was not enough indicia of fraud to support a finding of actual fraud.
3. The Tax Court found that dividends received by the minority shareholders in the years that the corporation was insolvent did constitute fraudulent conveyances subject to repayment. Keep in mind that a constructive fraudulent conveyance does not require actual fraud or intent to defraud. It can be enough that the payor is insolvent at the time of payment, and the payor did not receive fair value for its payment. A dividend from a corporation does not involve an exchange for fair value.
And in determining whether the corporation is insolvent, the funds inappropriately taken from the corporation must be deducted from the balance sheet, making it easier for the creditor to show insolvency.
4. In accordance with Florida law, the creditor, the IRS, was not obligated to exhaust its collection efforts first against the corporation, or the majority shareholders, before seeking to collect from the minority shareholders. Perhaps the minority shareholders have a cause of action against those other persons for any amounts paid to the IRS, but I suspect collectability against them may be a big issue. (See William J. Kardash, Sr., et al., TC Memo 2015-51).
Transferee liability for unpaid employer taxes can be brought under state legal rules or in equity. If the IRS brings the case in equity, exhaustion is required. If not, state legal rules control the exhaustion issue.
Even if an employee-owner is innocent of an actual fraud that caused the insolvency, that employee-owner can still be held liable under section 6901’s transferee liability provision.
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