We welcome back occasional guest blogger Marilyn Ames. As I have mentioned before Marilyn and I worked together at Chief Counsel’s office for many years though I mostly worked in Richmond and she in Houston. In retirement she calls upon her deep knowledge of collection and tax procedure issues to assist in updating the treatise edited by Les, “IRS Practice and Procedure.” More specifically, one of the chapters she assists in updating is Chapter 17 involving transferee liability. The case she discusses in this post will soon make its way into the treatise as do many of the cases we write about in PT. By reading the post you receive a little more depth that usually goes into the treatise and you receive the information a little earlier but if you do not look at the treatise you can lose some of the context provided by the expanded discussion of the issue in general. Enjoy the post and remember that the treatise can assist you in obtaining a greater understanding of the issue. Keith
Prior to the creation of the intermediary transaction, Section 6901 of the Internal Revenue Code was a sleepy little backwater whose appearance in litigation was mainly in cases involving tax protesters trying to keep from paying taxes by transferring their property to various trusts and family members. Section 6901 is a procedural mechanism that permits the United States to collect unpaid tax liability from insolvent taxpayers by reaching transferees who have received property belonging to the taxpayer in a fraudulent conveyance. Because Section 6901 is solely a procedural statute, the government must show the transferee is liable by using some other federal statute, such as the Federal Debt Collection Procedures Act, or the relevant state fraudulent conveyance statute. Currently, the vast majority of states have fraudulent conveyance statutes based on the Uniform Fraudulent Transfer Act, which was approved as a uniform law in 1984. Prior to that time, most states passed fraudulent conveyance statutes based on the 1918 Uniform Fraudulent Conveyance Act.
In the last years of the last century and the first years of this one, a company called MidCoast caused the government to take a second look at the use of Section 6901 when MidCoast began marketing a tax transaction to help shareholders that sold privately held corporations to save on the income taxes that would otherwise be owed on the sale. To do this, MidCoast, in what the Internal Revenue Service named an intermediary transaction, combined an asset and a stock sale of the privately held corporation. The corporation would sell its assets to an unrelated third party, thus triggering a tax on the corporation for any gain realized on the assets. The shareholders would then sell their shares to MidCoast, which would resell the stock to another not so unrelated third party. Although MidCoast claimed to borrow the funds from the purchaser of the shares to pay the shareholders, in actually it would use the cash held by the corporation from its asset sale, leaving the corporation insolvent with no way to pay its tax liability. MidCoast would set the price of the shares at the amount of the cash held by the corporation, less a percentage of the estimated tax liability triggered by the asset sale. MidCoast marketed at least sixty of these transactions.
In 2001, the Internal Revenue Service issued Notice 2001-16 (2001-1 CB 730), designating the “intermediary transaction” tax shelter as a listed transaction. Litigation began as to whether the government could collect the corporations’ tax liability from the former shareholders who had walked away with cash for their shares as transferees under Section 6901. Initially, the Tax Court was not sympathetic to the government’s arguments, and held in favor of the shareholders under various arguments. Some of these cases can be found in the Tax Court’s opinion in Julia R. Swords Trust v. Comm’r, 142 TC 317 (2014), the citations for which are replete with little red flags as the various circuit courts reversed and remanded many of these cases to the Tax Court. After the initial flood of reversals, the Tax Court got the hint and began finding transferee liability existed in most of these cases, based on the relevant state law, with the courts of appeal affirming the later decisions entered in the Service’s favor. (The Julia Swords case is an exception, notable as it was decided under Virginia law, which is one of the few states that has not passed a version of the Uniform Fraudulent Transfer Act).
The latest opinion in the Section 6901 litigation is that of Hawk v. Commissioner, 924 F3d 821 (6th Cir. 2019), and with this opinion the Sixth Circuit drives another nail in the intermediary transaction coffin for those cases decided in states with law based on the Uniform Fraudulent Transfer Act. The former shareholders in Hawk argued that they should not be held liable as transferees under Tennessee law as they did not know that MidCoast’s scheme was fraudulent, and without such knowledge, there was no fraudulent conveyance. The Sixth Circuit rejected this argument, noting that the Uniform Fraudulent Transfer Act, upon which the Tennessee act is based, replaced the language that an exchange of property was made for fair consideration if it was made in good faith, with the language that the transfer had to be for “reasonably equivalent value.” The “good faith” language had been part of the Uniform Fraudulent Conveyance Act, and the court held that the drafters of the Uniform Fraudulent Transfer Act had made the change to “reasonable equivalent value” to eliminate any inquiry into the transferee’s intent when determining whether a transfer is constructively fraudulent. The bottom line, the court holds is that the transferees’ “ ‘extensive emphasis on their due diligence and lack of knowledge of illegality’ doesn’t shield them from the sham nature of the transaction and absolve them of transferee liability.”
Apparently tiring of intermediary transactions and Section 6901 litigation, the court goes further and asks “Was there a way to make this tax-reduction strategy work?” The court’s answer is “ ‘maybe’ in the abstract and ‘not likely’ here.”
With the Hawk opinion, it appears that the litigation involving intermediary transactions may be on the wane, and that Section 6901 may be on its way back to the quiet little backwater where it previously spent its days.