The Tax Court held that three trusts that sold shares of stock in a corporation were not liable as transferees for the corporation's unpaid federal income tax liability incurred before its dissolution. According to the court, the IRS could not prove the taxpayers were liable under Florida law either as direct transferees or as transferees of a transferee.
Facts: In 2000, Sidney Alterman established a trust for the benefit of his three sons that later separated into three trusts, one for each son, funded by a large portion of the stock of Alterman Corp. (AC), a national freight hauling business based in Florida that he had founded. After Alterman died in 2001, his estate owed estate taxes of $12,502,994 that were paid with the proceeds of a loan from AC. Due to their father's death, their own failing health, AC's declining profitability, and AC's loss of working capital from the loan to the estate, the Alterman brothers decided to sell the AC stock owned by them, their trusts, and the estate.
Two potential buyers emerged: MidCoast Investments Inc. and Diversified Group Inc. The Altermans wanted the ultimate buyer to guarantee payment of AC's tax liabilities (from prior asset sales) and, for a minimum period, maintain a certain level of net worth and not dissolve or liquidate AC. Diversified offered more money than MidCoast but would not agree to the guarantees, so the Altermans sold AC to MidCoast on Dec. 5, 2003. Immediately after the sale, MidCoast sold the AC shares to the firm financing the acquisition, Sequoia Capital LLC, under an existing agreement of which the Altermans had no knowledge. On Dec. 8, 2003, Sequoia contributed $10.5 million to AC's Deutsche Bank account, and the next day AC transferred $16.78 million to an account in the Cook Islands in the name of Delta Trading Partners. (Neither party in this court case presented any evidence of what happened to the money.) The Altermans in 2010 successfully sued MidCoast for fraud and breach of contract, and many of the principals of MidCoast were indicted in 2013 for fraud.
AC reported no income on its 2003 federal income tax return after deducting a loss from the sale of interest rate swaps. After examining the 2003 return, the IRS disallowed the loss and assessed taxes and penalties totaling more than $7.3 million. Due to the dissolution of AC, the IRS assessed the amount against the three Alterman trusts on the basis that they were transferees of transferees under Sec. 6901. The three trusts petitioned the Tax Court for relief.
Issues: Sec. 6901 allows the IRS to collect a taxpayer's unpaid tax liability from another person if the other person is a "transferee" and an independent basis exists under applicable state law or state equity principles to hold the other person liable for the taxpayer's unpaid tax. The IRS must prove that a person is liable as a transferee but does not need to prove the existence of the taxpayer's underlying tax liability. The IRS argued that, in substance, the Alterman trusts received a liquidating distribution from AC and were liable for AC's tax as transferees. The Alterman trusts argued that the IRS could not prove they received fraudulent transfers under Florida's Uniform Fraudulent Transfer Act (FUFTA) and that they were not transferees under Sec. 6901.
Holding: The court held the trusts were transferees under Sec. 6901 but were not liable as transferees under FUFTA. The court did not permit the collapsing of all of the transactions under the equitable doctrine of substance over form because the Altermans had no actual or constructive knowledge that MidCoast planned to sell the AC shares and not honor the promises in the sales agreement.
The court also held that the IRS could not prove that the trusts were liable under various provisions of FUFTA. According to the court, under FUFTA, the trusts (1) did not engage in constructive fraud because it was MidCoast, not AC, that intended to engage in a transaction that would result in an inability to pay the tax liability; (2) did not engage in actual fraud because the IRS could not prove that AC made a fraudulent transfer to the shareholders or made a fraudulent transfer to the trusts with the intent to hinder, delay, or defraud the IRS; and (3) were not liable as persons for whose benefit a transfer was made because there was no evidence to link a benefit to the shareholders with the transfers of AC funds.
In addition, the court held that the trusts were not liable as transferees of transferees under the test developed in Frank Sawyer Trust, 712 F.3d 597 (1st Cir. 2013). Under the Sawyer test, the trusts would be transferees of transferees if the acquisition vehicles did not receive reasonably equivalent value at the time of acquisition and if the transaction left the acquisition vehicles with "unreasonably small" assets or the vehicles intended to incur debt beyond their ability to pay. The IRS failed to prove these two conditions with respect to the trusts, according to the court.
- John M. Alterman Trust, T.C. Memo. 2015-231
—By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota—Duluth.