(Originally published in the May 2012 issue of Bruce R. Hopkins Nonprofit Counsel, available electronically to subscribers on publication.)
It does not happen often, but a tax-exempt organization can find itself in the position of being liable for the taxes of another as a matter of transferee liability law or even as a transferee of a transferee. A US Tax Court decision issued on March 6 illustrates this potential (Salus Mundi Foundation, Transferee v. Commissioner).
A procedural statute authorizes the assessment of transferee liability in the same manner, and subject to the same provisions and limitations, as in the case of the taxes with respect to which the transferee liability was incurred (IRC § 6901(a)). That is, this law does not create a substantive liability but provides the IRS with a remedy for enforcing and collecting from the (or a) transferee of property the transferor’s existing liability.
The IRS may establish transferee liability if a basis exists under applicable state law or state equity principles for holding the transferee liable for the transferor’s debts. As noted, the IRS may collect unpaid taxes of a transferor of assets from a successor transferee of the assets.
In this case, highly appreciated assets of an organization (totaling about $319 million) were sold to another organization; the latter entity used a fraudulent tax strategy to offset or defer the built-in capital gains. All of this gave rise to unpaid federal income taxes and an accuracy-related penalty, owed by the seller. The IRS could not find any assets of the seller from which to collect the assessed liability and determined that any additional efforts would be futile. The agency then began looking about for transferees that might be liable. It focused on four private foundations.
The court found that the sales transaction was between unrelated parties and that the seller did not have knowledge of any past fraudulent activities of the buyer. It analyzed the fraudulent conveyance law in the state involved and concluded it should respect the form of the transaction.
The selling organization had conveyed assets to its shareholders, one of which was a private foundation. This conveyance of assets did not render the transferor entity insolvent. The court concluded that the conveyance was not a fraudulent one. Therefore, the foundation was held to not be liable as a transferee.
This foundation had transferred all of its assets to three private foundations, pursuant to a plan of dissolution approved by the state’s supreme court. Thus, had it been found liable as a transferee, it would not have had any assets, setting up the possibility that the three foundations would be liable for the taxes and penalty. But, inasmuch as the first of these foundations was not liable as a transferee, the court ruled that the three foundations could not be liable as transferees of a transferee.
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