In Sloan v. Commissioner, T.C. Memo. 2016-115, the U.S. Tax Court refused to apply transferee liability under Section 6901 to make a taxpayer who sold company assets to a third party liable for the third party’s tax liability. The court reached this conclusion even though there was some indication that the taxpayers’ advisers knew that the third party was interested in buying the business as part of a tax savings strategy.
Facts & Procedural History
The taxpayer was in the media and broadcasting industry.
The taxpayers were two trusts that owned Slone Broadcasting. Slone Broadcasting operated several radio stations in Tucson.
On July 2, 2001, Slone Broadcasting sold its assets to Citadel Broadcasting Co. (Citadel) for $45 million, which resulted in an estimated combined Federal and Arizona income tax liability of approximately $15 million.
Slone Broadcasting then became a holding company that did not conduct any business. Mr. Sloan’s CPA received several letters from Fortrend, a private investment/merchant-banking group, which proposed to purchase Slone Broadcasting.
Mr. Sloan’s CPA hired a tax attorney to investigate the transaction for Mr. and Mrs. Sloan.
The CPA and tax attorney knew that Fortend had a strategy to reduce income taxes, but were not provided details about the strategy. They were told that the strategy was proprietary.
They were also told that Berlinetta, Inc. (Berlinetta), an entity created by Fortrend that would acquire the shares, had not engaged in any transaction that would be deemed a “listed transaction” pursuant to Notice 2001-51, 2001-2 C.B. 190.
The parties agreed to a purchase price of $35,753,000 plus Berlinetta’s assumption of Slone Broadcasting’s Federal and State income taxes owed as of the closing date.
The tax attorney then wrote a memorandum describing Fortrend’s plan to offset the gains from the asset sale by contributing high basis/low value assets to Berlinetta in a Section 351 transaction and selling those assets at a loss before the end of 2001.
The sale closed and Slone Broadcasting changed its name to Arizona Media.
The IRS audited Arizona Media’s tax return and Arizona Media agreed to a tax adjustment.
Arizona Media failed to pay the assessed tax, penalty, and interest.
The IRS asserted that the taxpayer trusts and Mr. and Mrs. Sloan were liable for the tax based on trustee liability.
The U.S. Tax Court concluded that the taxpayer trusts and Mr. and Mrs. Sloan were not liable for the tax, as the sale was a legitimate transaction.
The appeals court remanded the case back to the U.S. Tax Court to apply the transferee liability tests for Section 6901. The court described the law as follows:
The first prong is satisfied if the party is a “transferee” under section 6901 and Federal tax law. The second prong is satisfied if the party is “substantively liable for the transferor’s unpaid taxes under state law”. Salus Mundi Found. v. Commissioner, 776 F.3d 1010, 1018 (9th Cir. 2014), rev’g and remanding T.C. Memo. 2012-61. Both prongs must be satisfied in order for liability to be imposed on a transferee. See Commissioner v. Stern, 357 U.S. at 44-45. Respondent has the burden of proving that petitioners are liable as transferees, but he does not have the burden of proving that the taxpayer is liable for the tax. See sec. 6902(a); Rule 142(d).
The court addressed the second prong, concluding that the taxpayers were not liable for Fortend’s unpaid taxes under Arizona law. The court considered Arizona’s Uniform Fraudulent Transfer Act (UFTA) laws.
Under Arizona law, the court concluded that the IRS must prove that the taxpayers had actual or constructive knowledge of the entire scheme in order for the asset sale to be recast as a liquidating distribution.
The court concluded that the taxpayers did not have this knowledge. This was based in part on Fortend not providing details about its tax strategies to the taxpayers or their advisers. This was also based on the idea that not all tax planning strategies are bad, citing prior case law:
“[T]here are legitimate tax planning strategies involving built-in gains and losses and * * * it was not unreasonable, in the absence of contradictory information, for the representatives to believe that the buyer had a legitimate tax planning method.”
The court also considered Arizona’s UFTA constructive fraud provision. This provides that a transfer by a debtor is fraudulent as to a creditor whose claim arose before the transfer was made if the debtor made the transfer without receiving reasonably equivalent value in exchange and was insolvent at that time or became insolvent as a result of the transfer.
The court noted that no transfer was made by Sloan Broadcasting, the debtor, the UFTA constructive fraud provision did not apply. The court went on to consider the factors set out in the UFTA, concluding that they did not establish constructive fraud.
As a result, there was no transferee liability under Section 6901. The court held that the taxpayers were not liable for the tax liability agreed to by the IRS and Fortend.