Background
The Dillon family created trusts in the nineteen thirties that owned two corporations, Humboldt and Shelby, which held significant assets including farmland and stock portfolios. In two thousand and two, the family sought to sell these corporations to avoid corporate-level taxes on built-in gains, preferring a stock sale over an asset sale. They engaged in an auction process that resulted in the sale of the corporations to a newly formed entity, Humboldt Shelby Holding Corporation, which was financed by Rabobank. Shortly after the sale, the new entity engaged in abusive tax shelter transactions to generate fictitious losses, resulting in no tax liability being paid. The IRS later determined the losses were artificial and assessed taxes, penalties, and interest against the entity. The IRS then sought to collect these amounts from the original sellers, the Dillon trusts, as transferees.
The court’s reasoning
The court reviewed the determination that the stock sale and subsequent asset sales could be collapsed into a single transaction under New York law. The court found that the Government met its burden of proving the Dillon trusts had constructive knowledge of the entire fraudulent scheme. The court noted that the trusts were sophisticated actors who recognized the tax liability problem and structured the deal to avoid it. The court concluded that the circumstances, including the creation of a new entity solely for the transaction and the immediate sale of assets, should have led the trusts to inquire further into the legitimacy of the tax attributes used to offset the gains. The court also affirmed the lower court’s rejection of the illegal exaction claim regarding interest accrual after the trusts made deposits under Section sixty-six zero three of the Internal Revenue Code.
What it means going forward
The decision reinforces the ability of the IRS to pursue transferee liability against sellers of corporations who are aware of or should have been aware of fraudulent tax avoidance schemes, even if they did not directly participate in the subsequent abusive transactions.
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