Julia, Maggie and Dotty and their numerous descendants are heirs of Grandpa Dick Reynolds, a primordial rapper, but spelled with a “w”. Dick invented Reynolds Wrap, a trusted ally in my kitchen and those of millions of others. He parked the C Corp stock in a PHC (of course), basis bupkiss (as we say), FMV astronomical, especially after Reynolds Aluminum merged with Alcoa fifteen years ago.
Dick’s son Dave put the PHC stock into family trusts, run by Dave’s daughters Julia, Maggie and Dotty. Julia, Maggie and Dotty, of course, followed Grandpa’s deathbed advice “Never sell nothing never”, until their trusted attorneys were approached by Seidman BDO, well-known accounting firm (full disclosure: they even did work for me thirty years ago, but not the dirty work hereinbelow set forth), with a wonderful deal: move your stock into an LLC, and sell it to our “financial buyers”.
You pay capital gains, and the buyer is stuck with the BICG. They buyer, of course, is anonymous and will borrow the money to pay you, and deal with the BICG.
See my blogpost “A Good Day for Taxpayers”, 3/15/11. But here innocence once more saves the innocent transferees of a Bialystok roundy-rounder, in Julia R. Swords Trust, Transferee, Margaret R. Mackell, Dorothy R. Brotherton, and Julia R. Swords, Co-Trustees, et al., 142 T. C. 19, filed 5/29/14.
IRS wants to use Federal law to collapse the sale of the stock into a liquidation of the PHC, distribution of the assets to Julia, Maggie and Dotty as trustees, and then a sale of the assets to the “financial buyer”, thereby rendering the PHC insolvent, and setting up a State law fraudulent transfer set-aside.
Nope, says Judge Marvel, writing for a unanimous Court.
“This Court has previously never explicitly adopted or rejected respondent’s proposed two-step analysis to decide whether a transaction should be recast under the Federal substance over form (or similar) doctrine when analyzing whether a transferee is liable under section 6901. Our approach, however, has been to require that State law allow such a transaction to be recast under a substance over form (or similar) doctrine before doing so.” 142 T. C. 19, at p. 38.
But Tax Court has always acted as if State law rules. Federal law decides if someone is a transferee, but State law decides if they should be liable for the unpaid tax. And Tax Court’s not changing now.
State law decides the form-over-substance jump-ball in a Section 6901 transferee liability case. “The Commissioner may collect the transferor’s unpaid tax from the transferee if an independent basis exists under applicable State law or State equity principles for holding the transferee liable for the transferor’s debts. Sec. 6901(a);Commissioner v. Stern, 357 U.S. at 45; Hagaman v. Commissioner, 100 T.C. 180, 183 (1993); Starnes v. Commissioner, T.C. Memo. 2011-63, slip op. at 15. State law determines the elements of liability, and section 6901 provides the remedy or procedure to be employed by the Commissioner as the means of enforcing that liability. Ginsberg v. Commissioner, 305 F.2d 664, 667 (2d Cir. 1962), aff’g 35 T.C. 1148 (1961); Starnes v. Commissioner, T.C. Memo. 2011-63, slip op. at 15. The applicable State law is the law of the State where the transfer occurred. See Commissioner v. Stern, 357 U.S. at 45; Starnes v. Commissioner, 680 F.3d at 426.” 142 T. C. 19, at p. 31.
There are three legs to the Section 6901 stool: transferor must owe unpaid tax, transferee must be a transferee as defined in Section 6901 (briefly one who got the boodle from the deadbeat taxpayer), and there must be independent State law or State equity basis for holding the transferee liable.
Judge Marvel chronicles all the losses IRS took trying to nail transferees in the roundy-rounders of Mid-Coast Financial and its imitators. And this is another one.
So no Federal form-over-substance here. State law doesn’t help, first because the only State (here the Commonwealth of Virginia) law has to do with a broker’s commission, and second because Virginia has its own fraudulent conveyance statute (doesn’t have the Uniform).
And Julia, Maggie and Dotty relied on their attorneys and accountants, as they had been doing for years, didn’t have a clue about the post-closing shenanigans of the “financial buyer” (of whose identity they were unaware pre-closing), and testified credibly on the trial as to their utter good faith.
Note that this may save Billyhawk and the hawklings when they go to trial. See my blogpost “Game Ends In No Score”, 5/30/12. There, Judge Wells wouldn’t buy Mrs Billyhawk’s affidavit and the hawklings’ paper averments that they knew nothing of Mid-Coast Financial and their skullduggery. But the trial may save them.
So the rappers’ tale has a happy ending–for the wrappers.