Federal Circuit Rejects Taxpayers' Arguments about Midco Transaction (5/17/26)

In Dillon Trust Co. LLC v. United States, ___ F.4th ___ (Fed. Cir. 2026), CAFC here and GS here, the Court in 50 pages rejects Dillon Trust’s bullshit claims in a bullshit “midco” transaction tax shelter. I wrote on one aspect of the case below. Court of Federal Claims Rejects Defective § 6603 Strategy for Multiple Transferee Liabilities (11/21/22), here (discussing one aspect of the Federal Circuit opinion).

The Federal Circuit offers a reasonable description of midco transactions (Slip Op. 10 n. 5):

5 A “midco transaction” or intermediary transaction is structured to allow a seller to engage in a stock sale and a buyer to engage in an asset purchase. Shareholders sell their C corporation stock to an intermediary (or midco) at a purchase price that does not discount for the built-in gain tax liability, as a stock sale to the ultimate purchaser would. The midco then sells the assets of the C corporation to the buyer, who gets a purchase price basis in the assets. The midco’s willingness to allow both buyer and seller to avoid the tax consequences inherent in holding appreciated assets in a C corporation is based on supposed tax attributes, like losses, that allow it to absorb the built-in gain tax liability. But, if these tax attributes of the midco prove to be artificial, then the tax liability created by the built-in gains on the sold assets still needs to be paid. In many instances, the midco is a newly formed entity created for the sole purpose of facilitating such a transaction, without other income or assets. It is thus likely to be judgment-proof, and the IRS will need to seek payment from the other parties involved in the transaction to satisfy any unpaid tax liability. 

That definition is antiseptic, eliminating details of the high- or low-drama presented in the rest of the opinion where the players on the taxpayer side unsuccessfully claimed a type of willful ignorance about the transaction to justify their participation and, they hoped, avoid the transferee tax liability involved. They failed.

The Court affirmed that the involved parties had at least constructive knowledge of the bullshit gambit and therefore could be liable under New York’s Uniform Fraudulent Conveyance Act (see Slip Op. 21-26). Based on the players involved (see Slip Op. 3 nn. 1-3), some of whom testified, this was ““[a] deal done by very smart people that, absent tax considerations, would be very stupid.” Michael Graetz statement, oft quoted, see e.g., Lynnley Browning, How to Know When a Tax Deal Isn’t a Good Deal (New York Times 10/10/08).

On what these taxpayers (including the company whose stock was purchased), their transferees, their advisors, and other players in the “deal” knew or should have known, the Federal Circuit affirmed the CFC holding of constructive fraud. (In my mind, the facts affirmed by the Federal Circuit might have even permitted a reasonable inference of actual fraud in the sense that the selling shareholders in the midco transaction knew enough to also know that the taxes were going to be avoided/evaded.) Readers might want to read through the opinion to appreciate the high- or low-drama.

Key bullet points of the holding are:

• Transferee liability under § 6901 applies and invokes the NY UFCA. (Slip Op. 20-39.)
• The amount of liability included the transferor corporation’s tax, penalties, and interest. On including the penalty, the Federal Circuit noted that there “appears to be a circuit split” on including penalties. (Slip Op. 42) The Court of Appeals adopted the majority of Circuits inclusion of penalties (Slip Op. 42-44.)
• The § 6603 deposit made by the Dillon Trust could not avoid interest on other taxpayers’ liabilities. Slip Op. 44-50.)

As I view it, the parties knew or should have known that, if the IRS spotted the transaction and spent the resources to "unpeal the onion," it would likely assert transferee liability. So, it seems that they rolled the dice on the audit lottery. These taxpayers lost that roll of the dice. But there are many others who have won that gamble.

Tax Court Denies Petitioner Summary Judgment on Transferee Liability (2/6/24)

In Meyer, Transferee v. Commissioner, T.C. Memo. 2024-15 (2/5/24), TC Dkt Entry # 44, here, TN here, and GS here, the Court denied the petitioner’s motion for summary judgment in a transferee liability case. The petitioner argued that (i) the statute of limitations for the IRS’s transferee liability claim was not timely under the statute of limitations, (ii) collateral estoppel precluded the IRS claim, and (iii) judicial estoppel precluded the IRS claim. The estoppel claims denials are straightforward. I focus here on the first claim about the statute of limitations.

The underlying transaction at issue was a typical Midco abusive tax shelter transaction (I have often called abusive tax shelter transactions bullshit tax shelters). I assume readers are familiar with Midco transactions. An example with a good discussion is in Tax Court (Judge Lauber) Rejects Shareholders' Attempts to Reduce Transferee Liability (Federal Tax Procedure 2/10/22). I will offer a high level overview of the Midco transactions (which have variants but with common result of an empty corporation with a very large tax liability). A Midco transaction involves a third party purchasing, directly or indirectly, stock of a corporation with very large built-in gain from shareholders for a price exceeding what they would obtain if the corporation sold the assets and distributed the cash. After the purchase, the buyer sells the assets and enters an abusive tax shelter transaction (such as the Son-of-Boss involved in this case) to supposedly offset the gain, and then strips out to assets (mostly cash) to leave the corporation empty when the IRS audits and disallows the tax shelter transaction. The supposed tax “savings” is shared by the shareholders (through the purchase price) and the promoters, leaving the IRS (and the country’s taxpayers) holding the bag in the empty corporation. Remember for the balance of this discussion that all of this hinges on the fraudulent Son-of-Boss transaction. In other words, the initial corporate transferor with the unpaid tax liability engaged in fraudulent reporting.

In Meyer, Transferee, the IRS asserted transferee liability under § 6901 by treating the corporate-level transactions as including a deemed transfer to the petitioner as transferee (rather than as a seller of the stock to a third party). For an initial transferee, such as the petitioner, the statute of limitations for transferee liability does not expire until one year “after the expiration of the period of limitation for assessment against the transferor.” § 6901(c)(1).

As posited by the Court, the first step is to establish when the statute of limitations expired on the deemed transferor—the sold corporation engaging in the Son-of-Boss transaction and fraudulently reporting the transaction to zero out the gain on the return. Normally, the limitations period is 3 years. And, the Court worked on the assumption that the 3-year period would have applied and counted certain other extensions or suspensions that extended the corporate transferor’s limitations period. The Court’s analysis is fairly straightforward, so I won’t rehash that here.

Tax Court (Judge Lauber) Rejects Shareholders' Attempts to Reduce Transferee Liability (2/10/22)

In Slone v. Commissioner, T.C. Memo. 2022-6, TC Dkt Entry 107 *, here, and GS here, after two reversals by the Ninth Circuit, the last of which held the related taxpayers liable for transferee liability from a Midco transaction, the Tax Court was tasked with determining the amount of the liabilities of the related taxpayers in order to enter judgment (decision) for the Commissioner. Judge Lauber took over the case from Judge Vasquez on 10/19/21. See Dkt Entry 103 *. The related taxpayers raised various arguments to reduce the amount of the liabilities. Hence, as Judge Lauber noted (Slip Op. pp. 2 & 3),

The IRS has calculated these numbers to include a deficiency of $13,494,884, an accuracy-related penalty of $2,698,997, and interest of $8,559,729, for a total of $24,753,610.

* *  * *

             The parties have submitted dueling Rule 155 computations. They agree that the transferor corporation’s total tax liability is $24,753,610. But they disagree as to the extent to which petitioners are liable for this debt. Petitioners contend that they are not liable for the penalty or “prenotice” interest, that the IRS has “double counted” the transfers, and that they are entitled to reductions for “equitable recoupment.” Finding no merit in the arguments petitioners tender in support of their computations, we will enter decisions as requested by respondent.

 Judge Lauber helpfully provides readers a synthesized summary of the prototypical Midco transaction (Slip Op. p. 3, case citations omitted):

Tax Court Holds the TFRP is a Penalty Subject to § 6751(b) Supervisor Written Approval Requirement (1/23/20)

Update 1/27/20 9:15am:  Bryan Camp offers an excellent discussion of Chadwick:  Bryan Camp, Lesson From The Tax Court: §6672 Trust Fund Recovery Penalty Is Really A Penalty ... Sort Of (Tax Prof Blog 1/27/20), here.

The Tax Court has been on a tear recently with precedential (including reviewed) T.C. opinions and significant T.C.M. opinions dealing with the nuances of § 6751(b)’s immediate supervisor written approval requirement.  See e.g., FTP2019 Update 05 - § 6751(b)'s Requirement for Supervisor Written Approval for Penalties (1/11/20; 11/23/20), here.  Tuesday, the Tax Court dropped another decision, Chadwick v. Commissioner, 154 T.C. ___, No. 5 (2020), here, holding that

A TFRP [Trust Fund Recovery Penalty in § 6672] is a “penalty” within the meaning of I.R.C. sec. 6751(b)(1). It is thus subject to the requirement that written supervisory approval be secured for the “initial determination of such assessment.

As I noted in the blog above, that was still an open issue, although Tuesday's Chadwick opinion, though precedential in the Tax Court, does not necessarily close the issue.  The IRS had taken the position that the TFRP is not a penalty for § 6751(b)’s immediate supervisor written approval requirement and may appeal.

The relevant portion of the opinion is Slip Op. 11-17.  That’s relatively short (those interested must read it), so I’ll just bullet point the key points in the Court’s analysis.

• The Code calls the TFRP a penalty.  “Section 6672 was in place in 1998 when Congress enacted section 6751, and Congress is presumed to have known that section 6672 refers to the liability it creates as a ‘penalty.’” (See Slip Op. 11 n. 2.)
• Congress placed § 6672 among the penalty sections of the Code.
• Section 6751(c) says that penalties include “includes any addition to tax or any additional amount.”
• The TFRP imposes liability for “willful” conduct, imposed as a sanction for not doing something.  “From the standpoint of the person sanctioned, they are “penalties” both as denominated by the Code and in the ordinary sense of the word.” (Slip Op. 15.)
• Apparently addressing the IRS argument that TFRP was a tax because assessed and collected in the same manner as taxes, the applicable section simply says that the TFRP and other penalties are collected “assessed and collected in the same manner as taxes.”  So this argument would exempt from § 6751 many penalties to which it plainly applies.  (Slip Op. 16.)

JAT Comments:

You Lie, You Lose -- Another Midco Transaction Fails (10/15/15)

I have discussed so-called Midco transactions in this blog before where a seller and buyer of a C Corporation with a built-in liability use a bullshit tax shelter to claim to eliminate the tax and share in the tax thus "eliminated." Yesterday, the Tax Court issued a new opinion in a Midco transaction where the parties tried to scam the fisc.  Tricharichi v. Commissioner, T.C. Memo. 2015-201, here:

The Tax Court offers this succinct explanation of the Midco transaction:

Although Midco transactions took various forms, they shared several key features, well summarized by the Court of Appeals for the Second Circuit in Diebold Found. Inc. v. Commissioner, 736 F.3d 172, 175-176 (2d Cir. 2013), vacating and remanding T.C. Memo. 2010-238. These transactions were chiefly promoted to shareholders of closely held C corporations that had large built-in gains. These shareholders, while happy about the gains, were typically unhappy about the tax consequences. They faced the prospect of paying two levels of income tax on these gains: the usual corporate-level tax, followed by a shareholder-level tax when the gains were distributed to them as dividends or liquidating distributions. And this problem could not be avoided by selling the shares. Any rational buyer would normally insist on a discount to the purchase price equal to the built-in tax liability that he would be acquiring. 

Promoters of Midco transactions offered a purported solution to this problem. An "intermediary company" affiliated with the promoter -- typically, a shell company, often organized offshore -- would buy the shares of the target company. The target's cash would transit through the "intermediary company" to the selling shareholders. After acquiring the target's embedded tax liability, the "intermediary company" would plan to engage in a tax-motivated transaction that would offset the target's realized gains and eliminate the corporate-level tax. The promoter and the target's shareholders would agree to split the dollar value of the corporate tax thus avoided. The promoter would keep as its fee a negotiated percentage of the avoided corporate tax. The target's shareholders would keep the balance of the avoided corporate tax as a premium above the target's true net asset value (i.e., assets net of accrued tax liability). 

In due course the IRS would audit the Midco, disallow the fictional losses, and assess the corporate-level tax. But "[i]n many instances, the Midco is a newly formed entity created for the sole purpose of facilitating such a transaction, without other income or assets and thus likely to be judgment-proof. The IRS must then seek payment from other parties involved in the transaction in order to satisfy the tax liability the transaction was created to avoid." Id. at 176. 

In a nutshell, that is what happened here. Petitioner engaged in a Midco transaction with a Fortrend shell company; the shell company merged into West Side and engaged in a sham transaction to eliminate West Side's corporate tax; the IRS disallowed those fictional losses and assessed the corporate-level tax against West Side; but West Side, as was planned all along, is judgment proof. The IRS accordingly seeks to collect West Side's tax from petitioner as the transferee of West Side's cash. We hold that petitioner is liable for West Side's tax under the Ohio Uniform Fraudulent Transfer Act and that the IRS may collect West Side's tax liabilities in full from petitioner under section 6901(a)(1) as a direct or indirect transferee of West Side. We accordingly rule for respondent on all issues.

The opinion is longer, but that is the opinion in a "nutshell."

Transferee-of-Transferee Liability (4/4/13)

In Frank Sawyer Trust of May 1992 v. Commissioner, 712 F.3d 597 (1st Cir. 2013), here, the First Circuit recognized that something suspicious had gone on in the "Midco" transaction case.  The quintessential circumstance that give rise to the Midco transaction is a closely-held C corporation that has sold all of its appreciated assets at a substantial gain, thus having only cash and a potential tax liability coming due at the end of the year.  For example, assume a sale of a $150,000,000 asset with $100,000,000 gain arising from the sale.  Assume a tax liability that likely would arise from the sale of $20,000,000.  The net value of the corporation is $130,000,000 -- i.e., $150,000,000 cash (the net sales proceeds) less $20,000,000 tax.  The shareholders can realize that value  by liquidating the corporation after paying the tax.  Or they can sell the stock to a third party who, logically, would be willing to pay only $130,000,000 because that is all the buyer would realize by taking the cash out of the corporation, provided that the corporate level tax were paid.  I am sure readers see an opening here.  What if the buyer could do something to cause the corporation to pay less tax? Then so long as the buyer can do that at less cost than the tax savings, then the buyer might be willing to pay more than $130,000,000.  For example, assume that the buyer could put an asset into the corporation that has a built-in loss of $100,000,000 and then use that loss to offset the $100,000,000 gain, so that there is no corporate level tax and thus there is $150,000,000 cash available for the buyer to take out.  Sweet.  And, what if the loss asset was phony, but the buyer stripped the $150,000,000 cash out of the company before the IRS realized the loss was phony and came looking for its $20,000,000 tax, plus penalties and interest?  And, what if the buyer through some complicated transactions, stripped the cash out in a way that the IRS cannot recover from the buyer (say the buyer spent it all or disappeared).

Now, go back and focus on the seller's side.  In a logical world, the seller might still sell the corporate stock for $130,000,000, for that is all that it is worth.  Why would the seller demand more?  All the seller has is corporate stock worth $130,000,000.  So, at least in theory, why would a buyer -- even one who thinks he can cause the tax liability to disappear -- pay much more than $130,000,000?  Presumably, in such a case, the logical buyer might pay just enough more to the seller that seller would have some incentive to fool with the buyer.  For example, in this case, the seller might insist upon $130,500,000 (that is a $500,000 sweetener to sell to the buyer rather than liquidate and get $130,000,000).  But that is not the way these deals -- at least the abusive ones -- get done.  The buyers put in a real sweetener -- that is they split the pot of gold, the tax of $20,000,000 -- between the buyer and seller.  For example purposes, let's say that the buyer agrees to pay $140,000,000 cash, meaning that the buyer gets $10,000,000 otherwise going to tax and the seller gets $10,000,000 otherwise going to tax.  (In the case, the deal was described as:  "a price equal to the value of the companies' assets (which by that point consisted only of cash) minus 50% of the value of the companies' tax liabilities.")  Sweet deal for both.

IRS Chief Counsel Remarks Involving Tax Procedure (11/20/12)

Tax Notes Today published prepared remarks of William J. Wilkins, IRS Chief Counsel.  The prepared remarks are for the BNA Bloomberg Tax Policy & Practice Summit on 11/14/12.  The prepared remarks may be viewed here.  I excerpt below the items I think are particularly important or interesting for a tax practice practice.

1. "There is also a Circuit split on the application of the 40% substantial overvaluation penalty in certain settings, so we are watching that."  This split is as to whether, if the case is resolved by some predicate issues (such as economic substance before getting to the overvaluation), the overvaluation penalty can apply.  The split is with virtually every circuit applying the penalty except the Fifth and Eleventh Circuits, both of which may be ready to join the crowd.

2.  The Chief Counsel is also concerned about tax avoidance in so-called Midco transactions:

Earlier in the litigation chain, we are working to develop the law of transferee liability as it applies to intermediary or Midco transactions -- in particular transactions where a closely held C corporation sells its assets but winds up not paying the corporate tax, because a "Midco" purchaser of the shares of the cash-rich company essentially disappears without causing the correct tax to be paid. The government has had a difficult time holding the selling shareholders responsible in these cases, and we are urging different outcomes in both trial and appellate settings. There is a clear tax administration interest, both in getting the correct tax paid in old transactions and in eliminating the feasibility of future generations of dishonest Midco promoters from succeeding. We believe that current law, when correctly applied, provides the needed tools, but we will also be open to legislative solutions should the courts take different views.

3.  He is also concerned  about FATCA implementation:

Problems with Wrongful Alter Ego and Nominee Liens (8/9/12)

A not-uncommon taxpayer self-help collection "defense" is to title property in the names of third parties in order to avoid IRS collection against the property.  The common law and state law developed legal protections for creditors to be able to get past the nominal titling of the property to third parties.  These protections appear in the form of concepts such as nominee and alter ego liability and transferee liability for transfers in fraud of creditors.  The IRS uses these concepts to take collection activity, including filing liens against the third party.  I cover these concepts in the Federal Tax Procedure Book (footnoted at pp. 610 - 620; nonfootnoted at pp. 446 - 453).

Tax Notes Today has an article summarizing a recent webcast on alter ego liens.  Amy S. Elliott, Increased IRS Use of Alter Ego Liens Causing Problems for Taxpayers, 2012 TNT 154-2 (8/9/12).  The key points are:

1.  The IRS is increasingly using alter ego and nominee liens which have, practitioners feel, "insufficient due process protections."  Problems with the process include lack of notice to the alter ego or nominee.  A practitioner noted that, since the use of the alter ego or nominee lien requires advance counsel approval, the Appeals Officer may be reluctant to override the counsel.

2.  One participant suggested seeking Taxpayer Advocate Service involvement as soon as an alter ego lien is improperly asserted.