The U.S. Court of Appeals for the Ninth Circuit today vacated and remanded a decision of the U.S. Tax Court concerning IRS notices of transferee liability sent to former shareholders of a corporation for the taxes owed by the corporation on its asset sale.
The case is: Slone v. Commissioner, No. 12-72464 (9th Cir. June 8, 2015)
The Ninth Circuit majority concluded that the Tax Court had not applied the correct standard. Read the Ninth Circuit’s decision [PDF 116 KB]
The case involves two sales: (1) the corporation (SB) sold all its assets (radio stations) to unrelated C at a gain, but had no plans to liquidate or make distributions with respect to its stock; and (2) later, the shareholders sold all of their SB stock for $35.8 million to unrelated B. After the stock sale, SB merged into a successor corporation, which engaged in a transaction that resulted in a tax loss. The tax loss offset the asset sale gain. The IRS assessed a deficiency against the successor corporation, and against the selling shareholders as transferees of SB under section 6901.
The IRS conceded that the selling shareholders received cash from B for their stock, and not cash from SB in liquidation for their stock. The IRS claimed, however, that the formal stock sale was to be disregarded because, in substance, the shareholders received cash in a liquidating distribution from SB. In this way, the shareholders qualified as transferees under section 6901, and were liable for the unpaid tax liability of the corporation.
The Tax Court concluded otherwise, and found that the formal stock sales had sufficient tax law substance so that the selling shareholders avoided transferee status under section 6901.
Section 6901 asks two separate and independent questions: (1) are the selling shareholders transferees under section 6901; and (2) are the selling shareholders substantively liable for the corporation’s unpaid tax liability under state law? Both questions must be answered “Yes” for transferee liability to result.
Today, the Ninth Circuit found that the Tax Court had applied the wrong legal standard in deciding the first of the two questions, regarding the status of the selling shareholders as transferees.
As the appeals court noted, the proper standard is one similar to sham transaction principles. That is, the shareholders must prove to the Tax Court that they had a business purpose for engaging in the stock sale other than tax avoidance, and must show that the stock sale had economic substance beyond the creation of federal tax benefits. The Ninth Circuit held that the Tax Court erred when it decided the shareholders were not transferees based on factors more relevant to the second of the two questions, regarding state law liability. For this error, the Ninth Circuit remanded the case back to the Tax Court.
One judge dissented to the remand regarding the first question, and reasoned that the evidence on record was sufficient to conclude as a matter of law that the shareholders were transferees. The evidence included the status of SB at the time of the stock sale as a "cash hoard" with no plan to conduct further business. The judge concurred to the remand regarding the second question.
As noted above, transferee liability under section 6901 requires a “Yes” answer to both questions. The Ninth Circuit corrected the Tax Court for using evidence relevant to the second question to answer the first question “No.” It will be interesting to see if the Tax Court uses the same evidence to answer the second question “No,” to reach the same ultimate conclusion that the shareholders are not transferees under section 6901.
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