Introduction
Kardash v. Commissioner1 provides an essential 11th Circuit reminder on the extensiveness of transferee liability for unpaid employer taxes. This article reviews the facts and opinion and then discusses planning tips.
Facts
Kardash was both a shareholder and employee of Florida Engineered Construction Products Corporation (FEC). Kardash and three others owned all the stock. Chairman Hughes and President Stanton owned 3 million shares apiece, Residential Division President Robb owned 75,000 shares, and Kardash owned 575,000 shares.
FEC did well from 1999 to 2005, with revenues from $39.9 million to $132.2 million. Revenues tumbled to $55.4 million in the financial crisis of 2007. FEC paid no federal income tax for any of those years, but in an apparent fraud, Hughes and Stanton removed, respectively, $62,037,927 and $56,469,747 from the company. Kardash also received considerable funds: $550,000 “Advance Transfers” in 2003-4 and $3,457,500 in “Dividend Payments” from 2005 to 2007.
The IRS notified FEC in 2009 of tax deficiencies, but never levied FEC’s bank accounts or seized other FEC assets. Ultimately, FEC agreed to a monthly installment payment of $70,000 until $129,130,131.60 was repaid. The IRS also pursued funds transferred by FEC to shareholders, under section 6901’s fraudulent conveyance provisions. Stanton was criminally convicted and paid restitution. Hughes’s estate agreed to a settlement. Robb and Kardash challenged transferee liability, resulting in Kardash’s appeal from a Tax Court decision holding him liable.
At the Tax Court, the IRS argued that both the advance payments and dividends were fraudulent under the Florida Uniform Fraudulent Transfer Act (FUFTA) because FEC was or became insolvent without receiving any value from Kardash. Kardash countered with three primary arguments: (i) the transfers were not fraudulent since they were part of his compensation; (ii) the transfers prior to 2006 could not be fraudulent since FEC became insolvent in 2006; and (iii) the IRS failed to exhaust its collection remedies before seeking transferee liability under section 6901.
The Tax Court ruled against Kardash’s exhaustion argument, because FUFTA allows recourse to all available remedies. The Tax Court accepted the compensation argument regarding the advance transfers but not as to the dividend payments. Furthermore, the Tax Court considered the 2005 dividend payment together with those to the other shareholders, finding that the entire dividend transaction led to the 2006 insolvency. Only the latter ruling was at issue in the appeal.
Opinion
The appellate court relied on Commissioner v. Stern,2 in which the Supreme Court treated section 6901’s predecessor (section 311 of the 1939 Code) as procedural, with the result that state substantive rules were used to ascertain transferee liability.3 Section 6901 permits actions in law or in equity. In equity, the IRS would have to exhaust all available remedies against FEC before pursuing Kardash.4 In law, however, the IRS follows state rules, and Florida does not have an exhaustion requirement. The IRS thus had no obligation to exhaust remedies against FEC before pursuing recovery from transferee Kardash.
In considering 2005 dividends, the court noted that FUFTA enables creditors to collect against debtor transferees pursuant to constructive fraud where the claim was created before transfer and the debtor transferred without “reasonably equivalent value in exchange and . . . was insolvent at that time or . . . became insolvent as a result of the transfer or obligation.”5
The appellate court found that the dividend payments were not compensation. Kardash and FEC labeled the payments dividends on IRS forms. The Tax Court had found the payments to be in respect of the shares owned rather than for services. These were dividends for which FEC did not receive reasonably equivalent value, establishing this element of constructive fraud under FUFTA.
In addition, the debtor must be insolvent at the time of the transfer or become insolvent because of the transfer, which can apply to a series of transactions.6 FEC was clearly insolvent at the time of the 2006 and 2007 dividend payments, so the court only looked further at the 2005 dividend. Kardash argued against aggregating his dividend of $1.5 million with the dividend transfers to the other shareholders (Hughes, $21.5 million, and Stanton, $16.6 million), claiming that the amount was so small it could not cause FEC’s insolvency. The court concluded that the dividend that led to FEC’s insolvency was paid proportionately to all shareholders, so it would not be appropriate to treat the Kardash payment separately. That was funds due to the IRS under FUFTA and section 6901.
Planning Tips
Transferee liability for unpaid employer taxes can be brought under state legal rules or in equity. If the IRS brings the case in equity, exhaustion is required. If not, state legal rules control the exhaustion issue.
Even if an employee-owner is innocent of an actual fraud that caused the insolvency, that employee-owner can still be held liable under section 6901’s transferee liability provision.■