Wednesday, March 25, 2015
Even Minority Shareholders Can Be Hit With Transferee Liability for Unpaid Taxes When the Corporation Does Not Pay the Taxes
Even Minority Shareholders Can Be Hit With Transferee Liability for Unpaid Taxes When the Corporation Does Not Pay the Taxes The Tax Court in Kardash v. Comm., T.C. Memo 2015-51 (2015) has just held that minority shareholders who are also high-level employees were liable for unpaid taxes as transferees, with respect to some of the monies the taxpayers received from the corporation. I.R.C. Sec. 6901(a) authorizes the IRS to pursue a transferee of property to assess and collect tax owed by the transferor. State law determines the liability, while Sec. 6901 authorizes the enforcement of that liability. In Kardash, taxpayer and another minority owner held less than 10%, and the company’s president, and its board chairman, owned the balance. Kardash was an engineer and was involved in the company's financial affairs. The company paid no income tax despite though it owed more than $120 million, and its majority shareholders siphoned substantially all of the cash out of the company. Kardash received his usual salary, which was not at issue but also "advances" and “dividends,” which were at issue. Pursuant to Sec. 6901, the IRS asserted approximately $5 million that Kardash received from the company in “advances.” In ruling for the Government, the Tax Court, citing several other decisions looked to Florida law to determine whether IRS has an obligation to pursue all reasonable collection efforts against a transferor before proceeding against a transferee. It determined that Florida law does not require a creditor to pursue all reasonable collection efforts against the transferor so the taxpayers could still be held liable. The Kardash Court also noted that the IRS could pursue Kardash without first exhausting collection efforts against the majority shareholders. Under Florida state law and the law of many states, transfers that are not in exchange for reasonable value while a debtor corporation was insolvent at the time of the transfer or became insolvent as a result of the transfer results in transferee liability. Kardash argued that the advances were actually payments of compensation and thus were reasonably equivalent value, i.e., the value of their work. The IRS urged that the advances were loans that the taxpayers never paid back, and, therefore the corporation did not receive reasonable equivalent value. The Court ruled the advances were payments of compensation but that the dividends were not compensation and thus the corporation did not receive equivalent value for the dividends. Therefore, the taxpayers were liable as transferees under Code Sec. 6901(a). Moral of the story is that anyone receiving funds from an entity that does not pay its taxes can be subject to transferee liability and the recipient of the funds should be sure to document the goods or services provided to the company for which payment is received or risk transferee liability.