Third Party Liability

If the IRS is unable to collect taxes from a taxpayer, the IRS may assess and collect taxes from third parties pursuant to Section 6901 of the Internal Revenue Code (“IRC”). Third party liability may be imposed on transferees and fiduciaries of the taxpayer.

A transferee is defined under IRC Section 6901(h) to include a donee, heir, legatee, devisee, and distributee. Treasury Regulation Section 301.6901-1 further provides that a transferee includes the shareholder of a dissolved corporation, the successor of a corporation, and the assignee or donee of an insolvent person. Transferees may be liable at law or in equity for a taxpayer’s unpaid tax, penalties, and interest. Transferee liability at law arises when the liability is directly imposed on the transferee by a federal law, state law, or contract. For example, California Corporations Code Section 1107 directly imposes liability on a transferee by providing, “the surviving corporation shall... be subject to all the debts and liabilities of [the former corporations] in the same manner as if the surviving corporation had itself incurred them.”

Transferee liability in equity is imposed by a court based on equity and fairness principles. It arises when there is actual or constructive fraud. Generally, the IRS must exhaust all collection remedies against the transferor before attempting to collect from a transferee in equity. A transferee in equity will only be liable up to the value of the transferred property at the time of the transfer. The IRS can collect from transferees in equity only if it can show that:

1. The party is a transferee under Section 6901 and federal tax law; and
2. The party is substantively liable for the transferor’s unpaid taxes under state law. Salus Mundi Foundation v. Comm’r, 776 F.3d 1010, 1018 (9th Cir. 2014).

The California Uniform Voidable Transactions Act, CA Civ Code Section 3439 (2019), (“CUVTA”) determines the existence of substantive transferee liability in California. Pursuant to CUVTA, a creditor may void a transfer in the following instances:

• “The debtor made a transfer or incurred an obligation... with actual intent to hinder, delay, or defraud any creditor of the debtor”;
• The creditor’s claim arose before the debtor made a transfer or incurred an obligation “without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was insolvent at the time or the debtor became insolvent as a result of the transfer or obligation”;
• “The debtor made a transfer or incurred an obligation... without receiving a reasonably equivalent value in exchange for the transfer or obligation, and the debtor either:
  • Was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction; or
  • Intended to incur, or believed or reasonably should have believed that the debtor would incur, debts beyond the debtor’s ability to pay as they became due.”

With respect to tax matters, the term “creditor” may apply to the IRS, FTB, or other government tax agency.

Transferees should be aware that the IRS must assess the liability against them “within 1 year after the expiration of the period of limitation for assessment against the transferor[.]” 26 U.S.C. Section 6901(c)(1). If there are multiple transferees, the IRS must assess any liability against the subsequent transferee “within 1 year after the expiration of the period of limitation for assessment against the preceding transferee, but not more than 3 years after the expiration of the period of limitation for assessment against the initial transferor[.]” 26 U.S.C. Section 6901(c)(2).

A fiduciary is a “guardian, trustee, executor, administrator, receiver, conservator, or other person acting in any fiduciary capacity for any person.” IRC Section 7701(a)(6). Under Section 6901(a)(1)(B), fiduciaries may be personally liable for income taxes, estate taxes, gift taxes, and penalties for failure to file a return or pay taxes of the estate, the decedent, or the donor.

If an individual is insolvent or an estate has insufficient funds to pay all of its debts, fiduciaries must pay the Government before any other creditors. If a fiduciary fails to do so, he or she may be personally liable for any payments that should have gone to the Government pursuant to 31 U.S.C. Section 3713. A fiduciary will be personally liable if he or she knew of the taxes owed or had information that would put a reasonably prudent person on notice that taxes were owed to the IRS. US v. Coppola, 85 F.3d 1015, 1020 (2d Cir. 1996).

The IRS has one year after the fiduciary liability arises or before the expiration of the statute of limitations to collect the tax, whichever is later, to make an assessment against the fiduciary.

Transferees and fiduciaries should be aware that even if the statute of limitations for assessment has expired under IRC Section 6901, the IRS may have other options to hold fiduciaries personally liable for taxes. Under IRC Section 7402, the IRS may file a lawsuit in District Court to establish transferee or fiduciary liability under state law. In this case, the federal statute of limitations for collections under IRC Section 6502 applies, because the IRS is not bound by a state’s statute of limitations. Therefore, the IRS has ten years from the date a tax is assessed to bring a lawsuit to collect from a transferee or fiduciary under IRC Section 7402. If the IRS brings such a lawsuit, it can also collect other types of taxes, including employment and excise taxes.

If you are concerned about third party liability and you want to consult an attorney, Ben-Cohen Law Firm is here for you. Our firm’s lead tax attorney, Pedram Ben-Cohen is also a licensed CPA and a Board Certified Taxation Law Specialist who can address your concerns about your potential third party liability. To schedule an appointment with Pedram, please contact us at (310) 272-7600 or fill out our online form.

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