Source: https://taxlitigator.me/2014/12/24/section-6901s-two-prong-inquiry-by-lacey-strachan/
Timestamp: 2019-04-22 00:44:54+00:00

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Although shareholders are generally not liable for debts of a corporation, shareholders may be liable for a corporation’s tax liability if they are considered transferees under a state’s fraudulent conveyance laws. Where such liability exists, § 6901 of the Internal Revenue Code (“IRC”) allows the IRS to assess and collect the tax liability from the transferee. In a decision published December 22, 2014, the Ninth Circuit explains the two-prong inquiry required by this code section—a determination must be made under federal law of whether the IRS may procedurally assess the tax against a party if transferee liability exists, and an independent, substantive determination must be made under the applicable state law of whether such liability exists.
On appeal, the Ninth Circuit clarified the two-prong test for liability under § 6901, which requires two inquiries: (1) is the party a “transferee” under § 6901 and federal tax law?; and (2) is the party substantively liable for the transferor’s unpaid taxes under state law?[viii] The Ninth Circuit held that these two tests are separate and independent inquiries, concluding that the two prongs of § 6901 are “independent requirements, one procedural and governed by federal law, the other substantive and governed by state law.”[ix] That is, the state law substantive inquiry of whether a transferee is liable for the transferor’s tax liability is independent of the procedural inquiry under Federal law of whether a party is considered a “transferee” under § 6901.
However, the Ninth Circuit found on appeal that the transaction should be recharacterized under the New York Uniform Fraudulent Conveyance Act, reversing the Tax Court’s finding that the foundation did not have constructive knowledge of the entire scheme.[xii] The Tax Court’s holding had also been appealed to the Second Circuit by another of the foundations on the same issue, in the case Diebold Foundation, Inc. v. Commissioner, 736 F.3d 172 (2nd Cir. 2013). In that case, the Second Circuit held on the same set of facts, issues, and applicable law that the foundation had constructive knowledge sufficient to support transferee liability under New York law.
The Ninth Circuit decided to follow the Second Circuit’s reasoning in vacating the Tax Court’s decision, explaining that “absent a strong reason to do so, we will not create a direct conflict with other circuits.”[xiii] The Ninth Circuit concluded that “[w]hile the question of the shareholders’ constructive knowledge is a difficult issue, we conclude that the Second Circuit’s decision is not demonstrably erroneous.” The Ninth Circuit accordingly reversed the Tax Court’s holding, and remanded the case to the Tax Court for a determination on (1) whether the foundation was a “transferee” under the first prong of the two-prong test; and (2) whether the tax was assessed within the statute of limitations.
LACEY STRACHAN – For more information please contact Lacey Strachan at Strachan@taxlitigator.com. Ms. Strachan is a tax lawyer at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. Additional information is available at http://www.taxlitigator.com.
[i] Salus Mundi Found. v. Comm’r, 2014 U.S. App. LEXIS 24240, 9-12 (9th Cir. Dec. 22, 2014).
[v] IRC § 6901(a)(1)(A)(I), (c)(2).
[vi] IRC § 6901(h); Treas. Reg. § 301.6901-1(b).
[vii] Salus Mundi Found. v. Comm’r, 2014 U.S. App. LEXIS 24240 (9th Cir. Dec. 22, 2014) (citing Comm’r v. Stern, 357 U.S. 39, 42, 44-45 (1958)).
[viii] Salus Mundi Found. v. Comm’r, 2014 U.S. App. LEXIS 24240 (9th Cir. Dec. 22, 2014).
[ix] Id. at 22-23 (quoting Diebold Foundation v. Comm’r, 736 F.3d 173, 186 (2nd Cir. 2013)).
[x] Salus Mundi Found. v. Comm’r, 2014 U.S. App. LEXIS 24240, 17 (9th Cir. Dec. 22, 2014).
[xiii] Id. at 24 (quoting United States v. Chavez-Vernaza, 844 F.2d 1368, 1374 (9th Circuit)).

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