In general, operating a business through an entity can provide limited liability in the event the entity is insolvent or goes out of business. Limited liability applies even to business taxes owed by an entity such as a C corporation. Some taxpayers have attempted to take advantage of that by causing a corporation to transfer to its shareholders assets that should be used to pay taxes. Such shareholders liquidate the corporation and ignore IRS attempts to collect. Absent Section 6901, the IRS might have no ability to collect the corporate taxes from the owners of the corporation. However, Section 6901 imposes transferee liability on the owners of the business who received such assets.

Although Section 6901 can apply in many different scenarios, in all cases it places the burden of proof on the IRS to show the transferee is liable. Also, for a transferee to be liable under Section 6901, it must be liable under the applicable statute of the state of the transferee. In most cases the statute relied on is the Uniform Voidable Transactions Act (formerly known as the Uniform Fraudulent Transfers Act). Almost all states have adopted the Act or its predecessor, although some states have made modifications to the uniform provisions. In North Carolina, the Act has been adopted as N.C.G.S. § 39-23.1 et. seq.

In a Section 6901 Tax Court case, the IRS must show a voidable transfer was made by the taxpayer to its owners pursuant to the applicable state law. That generally requires a showing that the taxpayer knew or had reason to know of the tax liability and transferred assets in an attempt to prevent the IRS from receiving funds in satisfaction of such liability. The Act can cause certain transfers to be voidable even when the liability arose after the transfer. Pursuant to N.C.G.S. § 39-23.4(a), “a transfer made or obligation incurred by a debtor is voidable as to creditor, whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred, if the debtor made the transfer or incurred the obligation: (1) with intent to hinder, delay, or defraud any creditor of the debtor; or (2) without receiving equivalent value in exchange for the transfer or obligation, and the debtor: (a) was engaged or was about to engage in a business or transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or (b) intended to incur, or believed that the debtor would incur, debts beyond the debtor’s ability to pay as they became due.” Therefore, Section 6901 can impose transferee liability on third parties who receive property in certain circumstances even if the taxpayer was not yet aware of the tax liability, such as where the taxpayer intentionally sold property for less than its full value.

Although the IRS has a high burden to invoke transferee liability under Section 6901, it is an important IRS collection tool.

John C. Hodnette is an attorney with Johnston, Allison & Hord in Charlotte.

November 10, 2022/by TAX