Court of Federal Claims Rejects Defective § 6603 Strategy for Multiple Transferee Liabilities (11/21/22)

In Dillon Trust Company LLC v. United States, ___ Fed. Cl. ___, 2022 U.S. Claims LEXIS 2575 (11/10/22), FC here and GS here, the Government moved for partial dismissal for lack of jurisdiction and for partial summary judgment with respect to plaintiff’s interest-related claim. I focus here on the interest-related claim.

The background is an intermediary or Midco transaction by a family corporation with the assets stripped out of the corporation by direct or indirect transfer to shareholders without paying the large tax corporate liability generated by the corporation. In initially reporting the transaction, the corporation claims the benefit of a bullshit tax shelter to effectively zero out the gain and tax, but on audit and denial of bullshit tax shelter benefit, the gain is taxed to the corporation which has no assets (because the shareholders stripped them out directly or indirectly). So, the IRS has to chase the “transferees” – here the shareholders – to collect the payment through transferee liability under § 6901.  I cover these transactions in Federal Tax Procedure (2022 Practitioner Ed.), here, at pp. 745-746. In a footnote, I quote Alterman Trust v. Commissioner, T.C. Memo. 2015-231, at *2:

Courts, including this court, have been plagued by Midco cases. Rarely do these cases present themselves for a determination of the underlying liabilities. Instead, these cases are postured so that the courts are asked to determine whether someone other than the taxpayer should be on the hook for the taxpayer's liability. They are transferee liability cases, and so are these cases.

The corporate taxpayer involved was Humboldt Shelby Holding Corporation (“HSHC”) which was unable to pay the tax, the gross valuation misstatement penalty, and the interest on each. The corporate liabilities as of August 2014 were “a federal income tax deficiency of $25,617,887 and a gross valuation misstatement penalty of $10,247,155, plus interest, which remained unpaid.” The transferees the IRS targeted were certain Dillon family trusts (with the parties agreeing that the results would apply to all of the family trusts as direct or indirect transferees). 

Among other arguments in this refund suit, the trusts argue that they cannot be held for transferee liability for the gross valuation misstatement penalty “because they lacked knowledge of HSHC’s plan to carry out the tax shelter scheme that formed the basis of the I.R.C. § 6662 penalty.”  Good luck to them on that. 

But in this case, the  court only addressed interest issues. The interest issue arose from the trusts’ apparent desire to invoke § 6603 to prevent the running of interest during the period of the deposit. I cover § 6603 in Federal Tax Procedure (2022 Practitioner Ed.) pp. 268-272. The rules of § 6603 are not particularly complex, but the application of those rules in the Dillon Trust case was complex because of the machinations involved where the trusts, as putative persons liable for transferee liability, apparently thrusted about to achieve some purpose to avoid interest but did so in which appears to be a haphazard fashion. The result is that, although the IRS had the deposit money in a large amount and for a significant period, the taxpayer and the transferees achieved no interest benefit under § 6603 that might have been achieved had they structured the deposits/payments differently.

I won’t go through those machinations because they are so fact specific and not likely to recur particularly if transferees contemplating the § 6603 strategy are represented by counsel who, if competent, will know or quickly discover this case. I will just note some of the key points (actual or implied) in the case that taxpayers and counsel should keep in mind. These holdings should be discernible or at least suspected from reading the statute:

1. A § 6603 deposit is made for a taxpayer and, I suppose in this context, a transferee with respect to transferee liability. The § 6603 deposit can only apply to the taxpayer’s or transferee’s liability for whom it was deposited.

2. A § 6603 “deposit is not a tax payment until and unless the IRS uses the deposit for a payment—these provisions would make no sense if a deposit was in fact the functional equivalent of a tax payment, regardless of whether the IRS used it for such a purpose.” (Slip Op 11.)

3. “[I]f the IRS does not use any portion of a deposit to pay tax, no interest-suspension benefit is triggered under § 6603(b). Indeed, § 6603(b) makes clear that it is only ‘[t]o the extent such deposit is used by the Secretary to pay tax’ that underpayment interest must be suspended. A taxpayer therefore has no statutory entitlement to a suspension of underpayment interest if the IRS does not actually use a deposit for a payment of tax.”

4. “§ 6603 does not require the use of deposits as tax payments, whether as a result of the IRS making an assessment or a taxpayer requesting the deposit to be used. Whereas other subsections of § 6603 mandate a certain outcome through the use of “shall,” § 6603(a) is pointedly permissive: 'A taxpayer may make a cash deposit with the Secretary which may be used by the Secretary to pay any tax imposed under subtitle A or B or chapter 41, 42, 43, or 44 which has not been assessed at the time of the deposit.' (emphasis added). The decision to use a deposit for a payment of tax is thus subject to IRS discretion, and the statute does not limit such discretion with conditions or exceptions.” (Slip Op. 11.)

5. If the taxpayer or transferee making a § 6603 deposit demands that it be refunded before the liability is finally determined and thus not applied to the liability, the benefit of § 6603 suspension of accrual of interest is lost.

6. The remittance of a § 6603 deposit should have a statement of disputable tax. My sense is that, given the IRS proceedings against HSHC, this was not an issue.

There are other lessons in Dillon Trust but that is enough for now. I am hoping someone else will take up the challenge to present the nuance of the case in a crisp manner.