Federal Law Governs Pre-Notice Interest in Transferee Liability Case Where Assets Received Greater Than Total Corporate Tax, Penalties and Interest

In the case of Tricarichi v. Commissioner, T.C. Memo. 2016-132 the Tax Court was asked to decide whether Ohio state law or federal law applied to the computation of interest owed for an individual found to have transferee liability under federal tax law. In an earlier case (T. C. Memo 2015-201) the Tax Court had found Michael liable for taxes due following a “Midco” transaction.

Roughly summarized, a “Midco” transaction involved the sale of a corporation owned by a shareholder who would sell his stock to a third party. In turn, that party would sell the assets of the corporation and use those assets to finance the purchase from Michael, leaving little or no assets in the corporation to pay the resulting corporate income tax. While the buyers claimed to have a way to offset that gain, the Courts have found in a number of cases that the shareholder should have realized the result was too good to be true and imposed transferee liability when the “offset” is later found invalid and a large corporate tax liability exists for a corporation with no remaining assets. Michael was one of those found to have such liability.

But now the question was how much interest (if any) Michael owed on the balance due before the date he was given notice of transferee liability. Michael claimed that the IRS was bound by Ohio state law and that under that law interest would not begin to be owed by Michael on this debt until the notice of transferee liability was given.

The Court notes the following regarding “pre-notice” interest:

Depending on the value of the assets received by the transferee and the aggregate tax liability owed by the transferor, the calculation of pre-notice interest may involve Federal and/or State law. These variables may also affect the rate at which interest is calculated and the date on which interest begins to accrue. Most State laws refer to the interest that may accrue during this period as “pre-judgment interest.” We will use the term “pre-judgment interest” to refer to interest that may accrue under State law during the pre-notice period.

The Court noted that the matter had been considered earlier in the case of Lowy v. Commissioner, 35 TC 393 (1960), holding that “where (as there) the value of the assets distributed to the transferee substantially exceeded the transferor's aggregate liability for deficiencies, penalties, and interest, the transferee's liability for interest is governed by, and must be computed in accordance with, the Internal Revenue Code.”

The Court notes that the actually liability escaped in question involves federal law, which provided that the corporation owed taxes, penalties and interest. Thus, the Court notes:

Surveying cases dating back to Cappellini v. Commissioner, 16 B.T.A. 802 (1929), we concluded in Lowy that ‘the quantum of the underlying claim that the * * * [IRS] is seeking to enforce against the transferee must be determined by the law which created that claim,” namely, the Internal Revenue Code. 35 T.C. at 396. Because the transferor's liability for tax, penalties, and interest is determined by the Federal statute, we deemed it “wholly inappropriate * * *, where the transferred assets are more than ample to discharge the full Federal liability of the transferor (including interest), to look to State law for the creation of any right to interest.” Id. at 397. On the other hand, "where the transferred assets are insufficient" to satisfy the IRS' claim against the transferor, "the creditor may have a further right to collect interest from the transferee, based upon the wrongful use of those assets by the transferee prior to payment.” Ibid. “The latter right is one that is founded on State law, and it is only in such circumstances that it becomes appropriate to investigate State law to determine the rate of interest, [and] the date from which it runs.” Ibid.

The Court then turned to the case at hand, finding:

In the instant case West Side's total Federal tax liability for 2003, including tax, penalties, and pre-notice interest computed thereon, is $35,086,437 (that is, $15,186,570 of tax + $6,012,777 of penalties + $13,887,090 of pre-notice interest as determined by respondent). In our prior opinion we found that petitioner received, as West Side's transferee, cash and cash equivalents with an aggregate value of $35,199,372. See Tricarichi, at *58. Because petitioner received assets with a value in excess of West Side's total Federal tax liability (including pre-notice interest), his liability for pre-notice interest is determined by Federal law.

The taxpayer argues that this analysis is flawed based on the Supreme Court’s decision in Commissioner v. Stern, 357 US 39. The opinion notes he argues:

...[E]mphasizing the Supreme Court’s ruling in Stern that State law controls "the existence and extent" of transferee liability, 357 U.S. at 45, petitioner contends that pre-notice interest should be determined under State law because it goes to “the extent” of such liability. Asserting that the First Circuit's Schussel opinion “highlights the continued uncertainty regarding computation of pre-notice [interest],” petitioner urges that the Lowy line of cases “should be revisited” in order to ensure adherence to the Supreme Court's mandate concerning the proper role of State law.

However, the Tax Court notes that a number of cases have been decided under the criteria noted in the sixty years since the Stern opinion was issued.

The Supreme Court issued its opinion in Stern almost 60 years ago, and the principal cases discussed above all post-date Stern. In developing the law concerning pre-notice interest, the courts have been fully conscious of, and properly faithful to, the Supreme Court's mandate. Far from manifesting uncertainty, the law that has evolved since Lowy appears quite stable and clear. Schussel is hardly a poster child for uncertainty: The IRS there urged that Lowy and Estate of Stein provided the critical guide-posts, and the First Circuit explicitly followed the reasoning of both cases. We have no reason to suspect that the Ninth Circuit, to which this case would be appealable absent stipulation to the contrary, see sec. 7482(b)(2), would take a different stance, see supra p. 11 and note 2.

The Court concludes:

In short, the courts have consulted State law to ascertain whether the Government may recover from the transferee, in the form of pre-judgment interest, an amount larger than the value of the assets the transferee received. Petitioner has cited, and our own research has discovered, no case in which a court has invoked State law governing pre-judgment interest as a basis for reducing the Government's recovery to an amount smaller than the value of the assets the transferee received. That is what petitioner seeks to do here, and there is simply no precedent for it.