Opinion ID: 856772
Heading Depth: 2
Heading Rank: 3

Heading: IRS's Petition for Review

Text: We review the Tax Court's legal conclusions de novo and its factual findings for clear error. Drake v. Comm'r, 511 F.3d 65, 68 (1st Cir. 2007). The IRS emphasizes two objections to the Tax Court's decision. First, the IRS argues that the Tax Court should have applied the federal substance-over-form doctrine to determine whether the Trust is a transferee for purposes of 26 U.S.C. § 6901 before looking to Massachusetts fraudulent transfer law. Second, the IRS challenges the Tax Court's factual finding that the Trust lacked constructive knowledge of Fortrend's tax avoidance scheme. Since a finding of constructive knowledge on the part of the Trust would have led the Tax Court to collapse the transactions under state law, see Frank Sawyer Trust, 2011 Tax Ct. Memo LEXIS 296, at , the IRS's challenge to this factual finding stands independent from its argument that the Tax Court should have applied the federal substance-over-form doctrine. -16-
The IRS first argues that the Tax Court erred by skip[ping] ahead to the state law issues before resolving the question of whether the Trust is a transferee for purposes of 26 U.S.C. § 6901. After reviewing the Service's claims, we see no reason why the Tax Court should have addressed the federal tax law question before the Massachusetts law question. While it is true that the IRS can only use the § 6901 procedural mechanism to collect taxes from a transferee as that term is defined by federal law, see 26 U.S.C. § 6901(h), it is also true that the IRS can only rely on the Massachusetts Uniform Fraudulent Transfer Act to collect from a transferee as that term is construed for the purposes of state law. Stern, 357 U.S. at 45 (existence and extent of the transferee's liability should be determined by state law); Starnes v. Comm'r, 680 F.3d 417, 419 (4th Cir. 2012). Thus, if the Trust was not a transferee of the companies for purposes of Massachusetts fraudulent transfer law, then whether or not it was a transferee for purposes of § 6901 is irrelevant. And if the Tax Court believed that it could resolve the case more expeditiously by deciding the question of state law liability before the federal tax law question, then it was not error for the court to consider the issues in that order. See Starnes, 680 F.3d at 430 (because the Commissioner has failed to prove the [f]ormer [s]hareholders are liable under state law . . . , we need not and -17- do not decide whether they are . . . 'transferees' . . . within the meaning of § 6901). The IRS also argues that Massachusetts courts apply something akin to the federal substance-over-form doctrine in fraudulent transfer cases. See, e.g., Galdi v. Caribbean Sugar Co., 99 N.E.2d 69, 71-72 (Mass. 1951). Moreover, the IRS contends that under the substance-over-form doctrine, the objective economic realities--not the parties' subjective beliefs--determine the characterization of a transaction. See, e.g., Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978) (objective economic realities are controlling). But although Massachusetts' highest court has said that [u]ndoubtedly, equity, particularly in cases of alleged fraud, will disregard the form to ascertain the substance of a transaction, the court said in the same breath that before it will disregard the form of a transaction, the litigants challenging the transaction's form must demonstrate that both parties to the transaction structured it with an intent to hinder, delay, and defraud. Galdi, 99 N.E.2d at 71-72. And here, the Tax Court found no such intent on the part of the Trust.1 1 The IRS further contends that the Tax Court erred by finding that there was no circular flow of funds among the Trust, the corporations, and Fortrend. But the circular flow of funds rule is an element of the tax law doctrine of substance over form. See, e.g., Merryman v. Comm'r, 873 F.2d 879, 882 (5th Cir. 1989) (a circular flow of funds among related entities does not indicate a substantive economic transaction for tax purposes). While Massachusetts courts may consider a circular flow of money to be evidence of a sham transaction in the context of a state tax -18-
Trying a different tack, the IRS argues that even if the Trust's knowledge of the scheme is required in order for us to collapse the two transactions into one, the Tax Court clearly erred in finding that the Trust lacked constructive knowledge of Fortrend's tax avoidance scheme. But the clear error standard presents a high hurdle, Pagán-Colón v. Walgreens of San Patricio, Inc., 697 F.3d 1, 15 (1st Cir. 2012)--too high a hurdle to jump over in this case. Here, the Trust's agreements with Fortrend all included provisions stating that Fortrend would be liable for the companies' taxes. The Trust's attorney, Walter McLaughlin, testified that he checked with Rabobank to confirm that Fortrend was a financially responsible operation; and Louis Bernstein, an advisor to Midcoast who participated in discussions between McLaughlin and Fortrend, testified that McLaughlin was pretty inquisitive about the propriety of the transaction. Moreover, case, see Sherwin-Williams Co. v. Comm'r of Revenue, 778 N.E.2d 504, 513 (Mass. 2002); Syms Corp. v. Comm'r of Revenue, 765 N.E.2d 758, 765 (Mass. 2002), the IRS never explains why the Tax Court's alleged error regarding circularity undermines the court's conclusion that, in the fraudulent transfer context, Massachusetts courts would respect the form of the Trust's transactions with Fortrend. Under Stern, when the IRS uses the procedural mechanism of 26 U.S.C. § 6901 to collect taxes from a transferee, the state law that applies is the state law regarding creditors' rights, not state tax law. See, e.g., Starnes, 680 F.3d at 420 (look to North Carolina law regarding creditors' rights); Ewart v. Comm'r, 814 F.2d 321, 324 (6th Cir. 1987) (IRS must look to Ohio's fraudulent transfer law for its rights as a defrauded creditor of the transferor-estate). -19- James Milone, who was chief financial officer of the corporations owned by the Trust, testified to his belief that there was nothing wrong with Fortrend's tax-related plans and that he was shocked when the IRS commenced its audit of the Trust. The Tax Court considered this testimony and concluded that [w]hile there is uncertainty as to the trust's level of inquiry regarding Fortrend's postclosing activities, the court could not find that the trust had constructive knowledge of Fortrend's scheme. We have said that [t]he process of evaluating witness testimony typically involves fact-sensitive judgments and credibility calls that fit comfortably within the margins of the clear error standard. United States v. Matos, 328 F.3d 34, 40 (1st Cir. 2003). Our standard for reviewing Tax Court decisions is the same as our standard for reviewing district court decisions in civil actions tried without a jury, 26 U.S.C. § 7482(a)(1), and [t]his mode of review requires us to accept the Tax Court's credibility determinations and its findings about historical facts unless, after careful evaluation of the evidence, we are left with an abiding conviction that those determinations and findings are simply wrong. State Police Ass'n v. Comm'r, 125 F.3d 1, 5 (1st Cir. 1997). Moreover, deferential 'clear error' review is especially appropriate when--as here--knowledge and intent are pivotal to the Tax Court's ruling and credibility determinations comprise a prime element of the court's ultimate conclusion. -20- Crowley v. Comm'r, 962 F.2d 1077, 1080 n.4 (1st Cir. 1992). The record includes testimony indicating that at least one of the Trust's representatives did conduct a good-faith inquiry into the propriety of Fortrend's contemplated transactions, and we defer to the Tax Court's decision to credit this testimony.