4.10.13  Certain Technical Issues

4.10.13.1  (03-30-2005)
Section Overview

  1. This section contains various technical examination topics that were previously omitted from the post-Modernization IRM. For easier reading, the topics covered and their subsections are listed below:

    IRM Subsection Topic
    IRM 4.10.13.2 Accumulated Earnings Tax (IRC Section 531)
    IRM 4.10.13.3 Transferor-Transferee Liability Cases
    IRM 4.10.13.4 Related Party Transactions (IRC Section 482)
    IRM 4.10.13.5 Adjustments Between Correlative Taxpayers (a/k/a Whipsaw Issues)
    IRM 4.10.13.6 Activities Not Engaged in For Profit - Hobby Loss (IRC Section 183)
    IRM 4.10.13.7 Change in Accounting Method
    IRM 4.10.13.8 Real Estate Developers: Alternative Treatment of Common Improvements Under Rev. Proc. 92-29
    IRM 4.10.13.9 Self-Rented Property and Renewable Options
    IRM 4.10.13.10 Personal Holding Company Deficiency Dividends

  2. Additional information on certain of the above topics may be found in the following Examining Officers Guide (EOG) IRMs:

    • IRM 4.11.52, Transferee Liability Cases;

    • IRM 4.11.5, Allocations of Income & Deductions;

    • IRM 4.11.6, Change in Accounting Method; and

    • IRM 4.11.47, Special Feature Cases.

4.10.13.2  (03-30-2005)
Accumulated Earnings Tax (IRC Section 531)

  1. The purpose of the accumulated earnings tax is to prevent a corporation from accumulating its earnings and profits beyond the reasonable needs of the business for the purpose of avoiding income taxes on its stockholders.

  2. Liability for the accumulated earnings tax is based on two conditions:

    1. The corporation must have retained more earnings and profits than it can justify for the reasonable needs of the business.

    2. There must be an intent on the part of the corporation to avoid the income tax on its stockholders by accumulating earnings and profits instead of distributing them;

  3. Any corporation within a chain of corporations can be subject to the accumulated earnings tax. A subsidiary corporation can be subject to the accumulated earnings tax even though the parent corporation is not subject to the accumulated earnings tax and vise versa.

  4. The accumulated earnings tax is computed on the corporation's accumulated taxable income for the taxable year or years in question. The accumulated taxable income is the corporation's taxable income with various adjustments. These adjustments are made primarily for the purpose of arriving at an amount that corresponds more closely to economic reality and thus, measures more accurately the corporation's dividend paying capacity for the year.

  5. The term "earnings and profits" is not defined in any of the revenue acts. The amount of earnings and profits for a taxable year usually is computed by adjusting taxable income in accordance with Treas. Reg. 1.312-6, 26 CFR 1.312-6.

4.10.13.2.1  (03-30-2005)
Considerations in Computing Accumulated Earnings and Profits

  1. In order for the examiner to make a true determination of the corporation's accumulated earnings and profits, the following items should be considered:

    1. Book "earned surplus" should be analyzed. The book account may have been reduced by the transfers to capital, or other accounts, in the form of stock dividends or reserves. Some accounting write-offs of surplus might not qualify as write-downs of earnings and profits for tax purposes. It is generally helpful to reconcile the surplus shown in the books to earnings and profits available for tax purposes.

    2. Life insurance proceeds are a part of earnings and profits and are available for dividend distribution.

    3. Excess of percentage depletion over cost depletion constitutes a part of earnings and profits.

    4. At some time during the history of the corporation, surplus may have been reduced by writing down purchased goodwill or other intangible assets. For this reason, the examiner should prepare a careful analysis of the earned surplus account for the year under examination and at least the five preceding years, and the amount and date of any cash dividends paid shortly after the close of the year under examination. If any distribution of dividends in reorganization was made, full details of such distribution should be stated.

4.10.13.2.2  (03-30-2005)
Indicators of Intent

  1. A prerequisite to imposition of the IRC Section 531 tax has been that the corporation be formed or availed of for the purpose of avoiding the income tax on its shareholders. As purpose involves a state of mind or intent, it is necessary to look at the surrounding facts and circumstances in each individual case to determine whether the purpose of the accumulated earnings was to allow the shareholders to avoid the income tax or for some other purpose.

  2. The following factors should be considered in determining whether the tax avoidance purpose was present:

    1. Dealings between the corporation and its shareholders, including loans to shareholders and expenditures of corporate funds for the personal benefit of the shareholders:

      • Corporate loans to or expenditures on behalf of shareholders tend to show that the corporation has the capacity to distribute these funds as dividends, particularly if there is a pattern of these transactions.

      • The loans or expenditures are substitutes for dividends and show that corporate earnings are diverted.

      • The examiner should include an analysis of amounts, if any, withdrawn by the stockholders in the form of loans or advances and reflected in the asset accounts at the close of the year under examination.

    2. Investments of undistributed earnings in assets having no reasonable connection with the corporation's business.

      • An inference may arise if the corporation has invested its funds for purposes which are not reasonably related to the business.

      • Such unrelated investments evidence the liquidity and dividend-paying capacity of the corporation, as well as an inference that the failure to distribute such funds as dividends was for the purpose of avoiding shareholder taxes.

    3. The corporation's dividend history.

      • A failure to distribute dividends or minimal payments indicates that earnings may have been accumulated to avoid shareholder taxes.

      • The examiner should include a statement showing the amount of taxes actually avoided by the principal stockholders through the failure of the corporation to distribute all of its earnings for the year under consideration.

      • Even if the corporation has a good dividend record and pays liberal officer-stockholder salaries, this does not in itself serve to rebut the tax avoidance factor.

4.10.13.2.3  (03-30-2005)
Holding or Investment Company

  1. The fact that a corporation is a "mere holding or investment " company is prima facie evidence that the corporation was formed or availed of for the purpose of sheltering its shareholders from income taxes.

  2. The examiner should set forth the basis for concluding the corporation is a mere holding or investment company and why it does not qualify as a personal holding company.

4.10.13.2.4  (03-30-2005)
Reasonable Needs of the Business

  1. Examiners should consider that the Code provides that earnings permitted to accumulate beyond the reasonable needs of the business shall be " determinative" of the purpose to avoid shareholder's income taxes unless the corporation shall prove to the contrary by a preponderance of the evidence. By virtue of this provision, most cases have been won or lost on the battleground of reasonable business needs.

4.10.13.2.4.1  (03-30-2005)
Effect of Prior Accumulations

  1. In determining whether current earnings were accumulated for reasonable business purposes, the examiner must make a determination of whether prior accumulations were, in fact, sufficient to meet the taxpayer's current needs. In making this determination, it is necessary to examine the character of the corporation's assets, since earnings used for the expansion of business plant or equipment, inventories, or accounts receivable cannot be readily distributed to the stockholders no matter how large the corporation's earned surplus may be.

  2. This issue requires a thorough analysis of the corporation's business and financial status for each year, including:

    1. Balance sheet position - meaning the size, character, and relationship of its various asset, liability and surplus accounts;

    2. Profit and loss statement;

    3. Liquidity and cash flow position;

    4. Type of business; and

    5. Economic conditions prevailing in the taxpayer's business.

4.10.13.2.4.2  (03-30-2005)
Factors to be Considered in Determining Reasonable Needs

  1. The term "reasonable needs of the business" includes the reasonably anticipated needs of the business.

  2. The following items, while not exclusive, may indicate that the earnings and profits are being accumulated for the reasonable needs of the business and should be used as guides:

    1. Bona fide expansion of business or replacement of plant;

    2. Acquisition of a business enterprise through purchasing stock or assets;

    3. Retirement of bona fide indebtedness created in connection with the trade or business, such as the establishment of a sinking fund for the purpose of retiring bonds issued by the corporation in accordance with obligations incurred on issue;

    4. Necessary working capital for the business;

    5. Investments or loans to suppliers or customers.

  3. Apart from the grounds specifically mentioned above, accumulations may be justified by a range of business needs. Among these are the following:

    1. Redemption of stock held by minority stockholders;

    2. Need to meet competition;

    3. Reserves for various business risks and contingencies such as self-insurance against casualties, potential liability from litigation, and unsettled business conditions.

    4. Need to finance pension or profit sharing plans for the employer;

    5. Possible loss of principal customer; and

    6. The IRC section 303 redemption needs of the business. Examiners should thoroughly investigate the facts and circumstances in the case with a view toward determining whether the redemption was for a corporate purpose or was primarily for the benefit of the stockholders in a redemption of the stock of a minority or a majority stockholder.

    7. The excess business holdings redemption needs of the business.

4.10.13.2.4.3  (03-30-2005)
Contingencies

  1. Accumulations have been justified as a result of various forms of contingencies including the following:

    1. An actual or potential lawsuit.

    2. A possible liability arising out of some contractual obligation.

    3. A possible business reversal resulting from the loss of a customer.

    4. Accumulations to guard against competition has been justified in some cases.

    5. An accumulation to provide funds to finance a self-insurance plan. This includes key men/women, as well as the more common types of risk insurance.

    6. Accumulations to provide a retirement plan for employees.

4.10.13.2.4.4  (03-30-2005)
Financing of Corporate Operations and Debt Retirement

  1. A corporation cannot be required to resort to the borrowing of funds under any circumstances. Therefore, the current operations of the business or planned expansion may be financed fully by retained earnings.

  2. An accumulation to retire a corporate indebtedness has in most cases been determined to be a reasonable need of the business, depending upon the reason the debt was created in the first place.

  3. The examiner should determine if the debt to be retired by the accumulation was bona fide and was incurred in connection with the trade or business.

4.10.13.2.4.5  (03-30-2005)
Effect of Subsequent Events

  1. Events subsequent to the end of the taxable year may not be used to show that retention of earnings and profits was unreasonable at the close of such taxable year if all the events indicated a reasonable accumulation at the close of the taxable year.

  2. Examiners may consider subsequent events to determine the taxpayer actually intended to carry out or has actually carried out the plans for which the earnings and profits were accumulated. The fact that the corporation did not, in fact, use the accumulated funds as originally planned does not necessarily mean that the accumulation was not reasonable when made. However, if the earnings are not used to accomplish the purpose for which they were to be used, this may indicate that the earnings were not to be used for the indicated purpose in the first place and will make any future accumulations more difficult to justify.

4.10.13.2.4.6  (03-30-2005)
Working Capital

  1. The working capital needs of a business are justification of accumulating earnings and profits.

4.10.13.2.5  (03-30-2005)
Operating Cycle Approach

  1. In 1965, the United States Tax Court introduced, in the Bardahl Manufacturing Corporation case, the operating cycle approach which involved the use of a mathematical formula in computing working capital requirements. There, the Tax Court permitted the corporation to accumulate enough working capital to cover the normal expenses of one operating cycle plus any anticipated extraordinary operating expenses.

  2. A normal operating cycle is the period of time required to convert cash into raw materials, raw materials into inventory of finished goods, finished goods inventory into sales and accounts receivable, and accounts receivable into cash.

4.10.13.2.5.1  (03-30-2005)
Selection of Appropriate Working Capital Formula

  1. Inasmuch as the need for working capital has long been recognized as the main reason for accumulating earnings and profits, the examiner should compute the Bardahl formula as modified by the Empire Steel Casting decision, on a preliminary basis by using the figures shown on the return to calculate reasonable working capital needs. If the taxpayer's net working capital exceeds the calculated reasonable working needs, then further analysis should be made following the procedures set forth in Exhibit 4.10.13-1 and Exhibit 4.10.13-2. See also IRM Exhibit 35.4.24-1.

  2. In an expanding business, the examiner should obtain the necessary financial information to compute the corporation's working capital needs in the years immediately preceding the year or years under examination and the years immediately succeeding the year or years under exam.

  3. For seasonal business, the Bardahl International formula is considered more appropriate for peak inventory and receivable months. For service business, the formulas should be modified to consider the average length of time required to perform on a contract rather than use the operating inventory turnover concept. The Apollo formula may have application to nonmanufacturing businesses. See Exhibit 4.10.13-3.

  4. As noted above, the Bardahl formula is " one test" and is not necessarily applicable to every IRC section 531 case. Examiners who are considering IRC section 531 should analyze each case with respect to specific facts before determining the type of operating cycle approach most appropriate.

  5. The latest criteria relied on in current court decisions should be considered.

4.10.13.2.6  (03-30-2005)
Relationship to Other IRC Sections

  1. Consideration should be given to the relationship between IRC sections 531, 541, and 551 since all three sections attack the problem of tax avoidance through undistributed earnings. An examiner may find that a potential IRC section 541 case is actually a good IRC section 531 case because the taxpayer does not qualify as a personal holding company.

4.10.13.2.7  (03-30-2005)
Data to be Furnished When Application of IRC 531 is Recommended

  1. The examiner should weigh all available evidence before proposing to apply IRC section 531. When it is determined that IRC section 531 should not be applied, the examiner will make a clear, concise statement in his/her report transmittal or workpapers supporting the recommendation.

  2. If an examiner recommends application of IRC section 531, he/she will include the data, specified in (3) below, in the workpapers or in the report transmittal. Since disclosure of certain information specified below might violate the disclosure provisions, the report will only include information considered vital to the taxpayer's understanding of the case.

  3. The examiner will include in the report transmittal or workpapers the following data:

    1. A history of the corporation from the date of its incorporation, fully setting forth the purpose for which it was formed. Plus comments, if applicable, regarding the following:
      assets transferred thereto,
      capital stock issued in exchange for such assets,
      actual paid-in capital,
      whether represented by par or no par stock, and if no par stock, the stated value, if any, ascribed thereto and
      kind of business in which engaged.

    2. Names and addresses of the principal or controlling stockholders and number of shares held by each at the close of the year involved.

    3. Names and titles of the officers of the corporation, stock ownership (if any) and amount of compensation received, if such information is not contained in the corporate return.

    4. A statement of substantial amounts, if any, withdrawn by the stockholders in the form of loans or advances and reflected in the asset accounts at the close of the year under examination.

    5. An analysis of the earned surplus account for the year under examination and at least the five preceding years, which will show in particular both taxable and nontaxable income, the amount of cash dividends paid during each of the respective years, and the amount and date of any cash dividends paid shortly after the close of the year under examination. If any distribution of dividends in reorganization was made, full details of such distribution should be stated.

    6. A statement showing the amount of taxes actually avoided by the principal stockholders through the failure of the corporation to distribute all of its earnings for the year under consideration.

    7. Review of corporate minutes for a discussion on why the funds are being accumulated (e.g. plans for plant expansion, debt retirement, inventory increases, etc.).

    8. Comparative balance sheets at the beginning and end of the year or years under examination, and five prior years.

    9. Whether or not, in the opinion of the examiner, the corporation is a mere holding or investment company and the basis for such conclusion and why it does not qualify as a personal holding company under the applicable revenue law.

    10. Any other facts and circumstances deemed pertinent by the examiner, including a summary of the material facts upon which the IRC section 531 recommendation is based.

4.10.13.2.8  (03-30-2005)
Notification of Unreasonable Accumulation of Earnings

  1. In any proceeding before the Tax Court involving the allegation that a corporation has permitted its earnings and profits to accumulate beyond reasonable business needs, the burden of proof is on the Commissioner unless a notification is sent to the taxpayer under IRC section 534(b). However, if such a notification is sent to the taxpayer and he/she timely submits the statement described in IRC section 534(c), the burden of proof will be on the Commissioner as to the grounds given in the statement.

  2. Operating officials who hold delegations or redelegations of authority to sign notices of deficiency pursuant to Delegation Order 4-8 (formerly No. 77) are also empowered to sign notifications under IRC section 534(b), such authority being derived from Treasury Department Order 150-36, 1954-2 C.B. 733. See IRM 4.8.8.2, Accumulated Earnings Tax, regarding coordination with Technical Services.

  3. Notification may be sent to the taxpayer prior to issuance of the 30-day letter. In general, the examiner will issue Letter 572 concurrently with the 30-day letter in cases with less than one year remaining on the statute (assuming sufficient time remains to issue a 30-day letter). The Area Director is responsible for issuing the notification when he/she plans to issue a notice of deficiency. This notification must be accomplished by the group before the case is forwarded for the 90-day letter. Appeals is responsible for issuing the notification in pre-90 day cases with more than one year remaining on the statute. This notification should be issued promptly to provide sufficient time, before expiration of the statutory period of limitation, for filing and adequate consideration of the statement.

  4. A notice of deficiency will not be issued before expiration of the period of time granted for filing the statement except when expiration of the period of limitation is imminent or other compelling circumstances require earlier issuance.

  5. If a jeopardy assessment is made under IRC section 6861(a), a separate notification need not be sent before a notice of deficiency is issued. In such instances the notice of deficiency, which must be mailed within 60 days after the date of assessment, constitutes the notification providing it informs the taxpayer that the deficiency includes the tax imposed by IRC section 531. The taxpayer's statement then may be included in the petition to the Tax Court.

  6. Notification under IRC section 534(b) will be issued on Pattern Letter P-572 (Exhibit 4.10.13-4), which must be manually signed, and sent by certified mail (by registered mail if the taxpayer's address is outside the United States). The number and disposition of copies of Pattern Letter P-572 usually will be the same as for a notice of deficiency. The records concerning the issuance of Pattern Letter P-572 by certified mail will be maintained under IRM. U.S. Postal Service Form 3877 should be noted: "Notification under IRC 534(b)."

4.10.13.2.9  (03-30-2005)
Rebuttal Statement by Taxpayer

  1. Treas. Reg. 1.534-2(d) allows a taxpayer 60 days after a notification is mailed in which to file a statement to justify the alleged unreasonable accumulation.

  2. If the taxpayer, for good cause, cannot submit the statement within the 60-day period, he/she may be granted an extension, not to exceed 30 days. He/she must request the extension before expiration of the 60-day period. SB/SE Delegation Order 4.3 states Compliance Section Chiefs, Group Managers in Technical Services and RA Reviewers GS-13 are delegated authority to grant an extension of time not to exceed 30 additional days.

  3. Pattern Letter P-572 (Exhibit 4.10.13-4) requires the taxpayer to submit an original and two copies of the statement. Upon receipt, the original should be attached to the return of the earliest year in which the issue is raised. One copy should be placed in the administrative file and the other copy should accompany the administrative file for further association with the Area Counsel's legal file.

  4. After consideration of the taxpayer's rebuttal, the issue will be dropped if it is concluded that earnings and profits have not been accumulated beyond reasonable business needs.

4.10.13.3  (03-30-2005)
Transferor-Transferee Liability Cases

  1. Transferee liability is a tool used to collect a taxpayer's tax liability. The transferor's tax liability is collected from persons or entities other than the taxpayer who incurred the liability. These third parties are known as "transferees" . Transferee liability does not create a separate liability for the transferee, but rather provides a secondary method for collecting the taxpayer-transferor tax liability. The government can assess another taxpayer's (transferor's) liability against a transferee to collect this tax liability based on some other provision of State or Federal law. IRC section 6901 states that the liability of a transferee will be assessed, collected, and paid in the same manner and subject to the same provisions and limitations as in the case of the liability of the taxpayer-transferor.

  2. The substantive basis of law for transferee cases is:

    1. The applicable State fraudulent conveyance state;

    2. The Federal fraudulent conveyance statute, effective for transfers made on or after May 29, 1991, subpart D of the Federal Debt Collection Procedures Act of 1990 (codified at 28 U.S.C 3301 to 3308), which can be asserted instead of or in the alternative to the applicable State fraudulent conveyance statute;

    3. An express or an implied contract;

    4. A state statute other then the fraudulent conveyance statute; and

    5. A federal statute.

  3. IRC section 6901 applies only to unpaid income, estate, gift and other taxes. Other taxes are defined as any other tax (employment, excise, and withholding), and only if such liability arises on the formal or de facto liquidation of a corporation, or partnership, or reorganization within the meaning of IRC section 368(a).

  4. The Area Director having jurisdiction in the initial determination of the income, estate, and gift tax liability of the transferor is responsible for proceeding, under IRC section 6901, against transferees or fiduciaries regardless of their location, and is responsible for all administrative action required in management and control of the case.

4.10.13.3.1  (03-30-2005)
Origination of Transferee Cases

  1. The two sources from which a transferee case can be generated are:

    1. As a referral from the Collection function, and

    2. As a related pick-up during an examination.

4.10.13.3.1.1  (03-30-2005)
Referral From Collection Function

  1. In an attempt to collect a tax liability, the Collection function may refer transferee cases to the Examination function for assistance.

  2. Collection prepares Form 3031, Report of Investigation of Transferee Liability, to recommend a transferee assessment. The Advisory Section reviews the report to ensure that pertinent factual data and adequate evidence is obtained to sustain assertion of the transferee liability. Once approved, the original report is forwarded to Planning and Special Procedures (PSP) to establish the transferee case on AIMS non-master file and to forward the case to an examination group.

4.10.13.3.1.2  (03-30-2005)
Transferee Case Initiated During a Related Examination

  1. Examiners are required to consider collectibility in every examination. As such, they must be able to identify situations in which the taxpayer has intentionally or inadvertently placed assets out of the legal reach of the IRS. Additionally, they must be able to identify situations in which asset transfers may not be conducted in a "normal business manner " because of the close relationship of the parties involved.

  2. If the taxpayer gives an indication of insolvency, the examiner should try to learn about the disposition of the taxpayer's assets and/or the transferee's legal responsibility for payment of the transferor's tax liability. The examiner must consider whether the elements of a transferee examination, as described below, have been met.

  3. A transferee case will be initiated once the examiner determines:

    1. The taxpayer has, or will have, a tax liability that cannot be collected directly,

    2. The elements of a transferee case have been met, and

    3. All or part of the tax liability could be collected from the transferee.

  4. Examiners are responsible for the identification and development of potential transferee cases that arise during their examinations. Examiners should not assume that Collection will develop a transferee case after the transferor's examination is concluded. By the time a case is routed to a Revenue Officer (RO) for collection, the transferee statute of limitations may prevent adequate consideration.

4.10.13.3.2  (03-30-2005)
Types of Transferee Liability and Burden of Proof

  1. There are two basic types of transferee liability. Both can be asserted under IRC section 6901; however, the extent of the liability depends on the law underlying the two types of transferee liability, the value of the equity in the transferred assets, and the amount of taxes due from the transferor. The type types of transferee liability are:

    1. Transferee in Equity, and

    2. Transferee at Law.

4.10.13.3.2.1  (03-30-2005)
Transferee In Equity

  1. Transferee Liability in Equity is the most common form of transferee liability. A Transferee in Equity is a person or entity who receives the transferor's assets for less than full, fair and adequate consideration, leaving the transferor insolvent and unable to pay the tax liability. Transferee in Equity cases are predicated on State or Federal Fraudulent Conveyance Statutes (i.e., 28 U.S.C 3301-3308).

  2. The liability of a transferee in equity is limited to the lesser of the value of the assets received from the transferor, plus possible interest, or the total outstanding tax, penalties and interest owed by the transferor.

  3. The Government must prove the value of the assets transferred. Where the assets transferred are subject to existing liabilities or assumed by the transferee, the value of the property received should be reduced by the associated liability in determining the limit of transferee liability.

  4. It should be noted that the mere fact that the transferee uses assets which he receives to pay debts of the transferor will not relieve him of transferee liability. He/she must also show that the debts paid had priority over the tax liability. A transferee does not cease to be a transferee merely by selling the transferred property. Additionally, the price at which the transferee sells the property is not an accurate measure of the transferee liability. Rather, the liability is measured by the value of the property that was transferred on the date of transfer.

  5. Even though a taxpayer admits that he is a transferee of assets of a dissolved corporation, unless he admits the extent of his liability, the Government must still prove the value of the assets so received in order that the Court can determine the amount due from him.

  6. The five elements that must be proved by the Government to establish transferee liability are:

    1. A transfer of assets from the transferor to the transferee for less than adequate and full consideration. In this regard, the Government must establish by evidence the value of the assets transferred in order to show that the transfer was for less than full and adequate consideration. Documentation must show:

      1. The asset was transferred (i.e., deeds, balance sheets, cancelled checks, title transfers, etc.),

      2. The value of the asset transferred at the date of transfer ,

      3. The consideration, if any, paid for the asset(s), and

      4. Who received the assets. The documentation must show the current legal title. A transferee is rarely a joint entity.

        Example:

        If a corporation made one check payable to the shareholder husband and one check to the shareholder wife, there would be two separate transferee cases - one for the husband and one for the wife. One transferee case in the joint names would not exist since the checks were not made out in joint names. If land was transferred to them jointly (i.e., joint ownership, such as tenancy by the entireties) there would be only one transferee - the husband and wife as joint tenants.

    2. The transfer of assets must have been made after the liability for taxes accrued. State law will govern regarding a requirement that the taxes be assessed. The fundamental basis of transferee liability is that the transferor, by the transfer of assets, wrongfully deprived the creditor of a chance to satisfy the debt out of the asset(s) transferred. The chance to satisfy the debt out of the asset(s) transferred never existed where the transfer was made prior to the taxable period involved. Therefore, no transferee liability can ordinarily arise when the transfer is made before the period in which the tax liability is created. However, the tax liability need not have been asserted prior to the transfer. In this connection, the tax liability need only accrue. The examiner should consult with Technical Services and/or Area Counsel in unusual circumstances. Documentation must show:

      1. The date the tax liability accrued. The tax liability accrues at least by the last day of the tax period, not the due date of the return. In some cases (such as lottery winnings), a transfer during the tax year may be argued to include an accrued tax liability since the income was earned prior to the year end and the transfer was obviously fraudulent. There is no requirement that the tax liability be assessed at the time of the transfer.

      2. The date the transfer took place.

    3. The transferor is liable for the tax.

      1. It would appear to be self-evident that unless the transferor is liable for the tax, there could be no liability asserted against the transferee.

      2. IRC section 6902(a) states, in part, that the Government does not have the burden of proof "to show that the taxpayer was liable for the tax" . There is a presumption of correctness in the Commissioner's determination, and unless the transferee offers evidence as to the transferor's tax liability, the amount established by the Commissioner will be sustained. If the transferee contends that the transferor owes no tax, the burden of proving this rests on the transferee. If there has previously been a decision on the merits, the transferee is collaterally estopped from raising the issue of the transferor's tax liability. Documentation must show the tax liability (i.e., transcript of account, Revenue Agent's Report, Notice of Deficiency, etc.).

    4. All reasonable efforts must have been made to collect the tax liability from the taxpayer before the proceeding against the transferee is commenced.

      1. It has been held by the courts that the liability of the transferee is secondary and that the Government must exhaust all legal remedies against the transferor before attempting to collect from the transferee. The extent to which the Government must proceed in each case to collect the tax from the transferor will depend upon the facts and circumstances of each case.

      2. However, there are exceptions to the above requirement. It has been held that the Government was not required to institute proceedings against the transferor, which would obviously be useless and futile, before proceeding against the transferee(s). For example, the transferor is deceased and the estate not probated or the transferee agreed to the assessment.

      3. It would also be unnecessary to sue a corporate-transferor stripped of its assets before proceeding against the transferee.

      4. Documentation should show that the transferor is in bankruptcy, has dissolved, or has distributed all of the assets and collection is not possible or that collection was pursued but could not be secured. A TXMOD will show the action taken by Collection function.

    5. The transferor was insolvent when the transfer was made or the transfer of assets left the transferor insolvent.

      1. As stated earlier, the mere fact that there has been a transfer of assets does not establish transferee liability. Any individual may transfer property for little or no consideration, without causing any liability to the transferee, provided the transferor was solvent at the time he/she transferred the property. In cases involving constructive fraud (transfers made without intent of hindering the government's collection efforts, but efforts to collect the transferor's tax liability was hindered), the Government must also prove that the transferor was insolvent when the transfer was made or the transfer of assets left the transferor insolvent. Insolvency need not be present in cases involving actual fraud (i.e., transfers made with specific intent of hindering the government from collecting the transferor's tax liability). The transferor's insolvency is an essential element of constructive fraud, but it does not need to be established when actual fraud exists. The examiner will need to look to the applicable state fraudulent conveyance statute and/or Subpart D of the Federal Debt Collection Procedures Act (28 U.S.C. 3301-3308) for the basis on which actual fraud could be found. It was previously mentioned that the test for determining insolvency is the comparison of the fair market value of the transferor's assets with his/her liabilities at the time the transfer occurred. If his/her liabilities exceeded his/her assets, the transferor was insolvent.

      2. The liabilities should include liability for taxes, penalties and interest to date of transfer. It should also include additional liabilities as a result of an examination (i.e., when it is found that the transferor embezzled money, the legal duty to repay the embezzled money would be included as an additional liability). However, in calculating the value of the transferor's assets, only those assets which could be reached by the Government to satisfy the tax debts are considered. This means that assets exempt from levy would not be considered as assets in determining insolvency of the transferor.

      3. The fact that the transferor was insolvent at one time during the year does not establish proof of insolvency at the time he/she made the transfer and if several transfers were made, the Government must make a separate determination of insolvency for each of the transfers involved.

      4. In many instances, the Government's transferee suit occurs several years after the transfer took place. It goes without saying that the greater the span of time between the transfer date and the institution of the suit, the more difficult it becomes for the Government to prove insolvency.

      5. Documentation should show that the transferor's tax liabilities and other liabilities (mortgages, debts payable, etc.) exceeded the transferor's assets at the time of transfer. For example, a copy of the transferor's balance sheet at time of insolvency, documents showing bankruptcy, documents showing dissolution of a corporation (contact Secretary of State), documents showing how the assets in a decedent's estate were distributed, etc., should be obtained to support this.

      6. Where a transferee transfers assets to a third person without consideration, the third person, who now becomes a transferee of the transferee, may be liable for the tax liability of the original transferor. This liability is limited to the extent that the second transferee received assets identified as originally belonging to the transferor. However, the transferee liability can only be asserted against the "transferee of the transferee" if:

        1. The first transferee was liable as such, and

        2. The second transferee received the assets under circumstances making him/her liable at law or in equity for the liabilities of the first transferee.

      7. If the assets of one corporation are transferred to another corporation without consideration, the second corporation is certainly a transferee and is liable, to the extent of assets received, for any tax impost upon the first corporation. If all of the assets of the second corporation transferred without consideration to a third corporation, the third corporation is liable to the extent of the value of the assets which belonged originally to the first corporation.

      8. Where a transferee transfers to a third person for full and valuable consideration the assets previously received from the transferor, he/she does not thereby cease to be a transferee, nor is the price at which he/she sold the property the measure of his/her liability.

4.10.13.3.2.2  (03-30-2005)
Transferee At Law

  1. A transferee at law is a person or entity that is responsible for payment of the transferor's tax liability due to:

    1. A contractual agreement that was entered into with the taxpayer, such as Form 2045, Transferee Agreement, or an assumption or guarantee agreement. A valid contract must exist and the Government must show that the transferee assumed the tax liability of the taxpayer, whereby the buyer agreed to pay the transferor's debts as part of the acquisition price.

    2. State statutes:
      (1) Most states have adopted some form of the Uniform Commercial Code (UCC). Article 6 of the UCC governs bulk sales and establishes liability of persons who purchase substantial inventory or equipment from a merchant if certain procedures are not followed.
      (2) Many states impose liability upon surviving corporations in reorganizations such as mergers and consolidations.

      Since the Government is considered a creditor, the Government would be a party to utilize the remedy provided by State law.

    3. Federal statutes such as liability of representatives of persons or estates who pay other debts before paying federal tax debts (31 U.S.C. 3713(b)), and liability of recipient of non-probate assets includible in descendant's gross estate (IRC section 6324(a)(2)).

  2. In transferee at law situations (i.e., (a), (b), and (c) above) insolvency of the transferor is not an issue. The government is relieved of this burden.

  3. In determining the extent of the transferee's liability at law, the value of the assets received by the transferee is immaterial since the extent of such liability is determined by reference to the amount of tax liability of the transferor that the transferee has agreed to pay (determined by contract or statute). Where transferee liability is based on estoppel, the liability is limited to the value of the assets received. Some state statutes may also limit liability to the value of assets received.

  4. Documentation required for transferees at law must show:

    1. The assets that were transferred and the fair market value at the date of transfer;

    2. A transcript of account showing the tax liability of the transferor for a period which accrued prior to the transfer and remained unpaid at the time of the assertion of transferee liability; and

    3. At the time of transfer of the assets, the transferee assumed the tax liability of the transferor by contract or statute. A copy of the contract and/or statute should be obtained.

  5. Statutory mergers where the surviving corporation is primarily liable for the debts of the merged corporation do not result in a transferee situation. The resulting surviving corporation is not a transferee, but is liable the same as the prior transferor corporation. Consult the contracts and agreements affecting the merger to see what type of transaction occurred.

4.10.13.3.3  (03-30-2005)
Statutory Period and Consents

  1. A transferee is considered a separate entity. The statute of limitations for the transferee is separate and distinct from the transferor's statute of limitation.

  2. The period of limitation for the assessment of the liability of a transferee is as follows:

    1. The initial transferee - one year after the expiration of the period of limitation for assessment against the transferor, as shown by the filing date of the original return or as extended by Form 872 or other statute extension form.

      Note:

      When the transferor's statute has been extended using Form 872-A and the transferor's tax liability has been assessed, Form 872-A is terminated. The computation of the transferee's statute of limitation will be one year from the assessment of the transferor's liability.

    2. A transferee of a transferee - one year after the expiration of the period of limitation for assessment against the preceding transferee, but not more than three years after the expiration of the period of limitations for assessment against the initial transferor.

    3. A fiduciary - not later than one year after the liability arises or not later than the expiration of the period for collection of such tax, whichever is later.

    4. Fraud - IRC section 6501(c)(1) provides that, where the transferor files a false or fraudulent return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at anytime. In such cases, the statute of limitations on the transferee would also be indefinite, since the transferee's statute is open for one year after the transferor's statute expires. However, unless the transferor's fraud penalty has been definitively established by judicial decision or otherwise, such as by agreement (Form 870), the transferee's statute of limitations should be protected by a consent form. Where the transferor's fraud penalty has not been definitively established, do NOT rely on fraud to keep the transferee's statute of limitations open. Securing a statute extension by consent from the transferor will protect the Government's interest in the event that the fraud issue against the transferor is lost.

  3. When it is necessary to extend the statute of limitations of transferees who are not primarily liable, the consent form used is Form 977, Consent to Extend the Time to Assess Liability at Law or in Equity for Income, Gift, and Estate Tax Against a Transferee or Fiduciary, or Form 4016, Consent Fixing Period of Limitation Upon Assessment of Employment or Miscellaneous Excise Taxes Against a Transferee. The extended date on Form 977 or Form 4016 may not be equal to or shorter than the statutory period prescribed by IRC section 6901(c). The consent will be secured in duplicate.

  4. When a Form 977 or Form 4016 is executed and no Form 2045, Transferee Agreement, has been secured, the transferee may subsequently raise the defense that the transferor is liable (by claiming that he/she is not a transferee). In this situation, the Service may only be able to proceed against the transferor if a Form 872 has been secured. To be safe, it is wise to secure consents from both the transferee (Form 977 or Form 4016) and the transferor (Form 872) until it has been determined who is liable for the tax.

4.10.13.3.3.1  (03-30-2005)
Trust Fund Doctrine

  1. If the period of limitations for assessment against a transferee has expired, action against the transferee under the trust fund doctrine for the collection of the unpaid tax assessed against the transferor should be considered. If timely assessments have been made against the transferor and the period for instituting suit for collection provided in IRC section 6502(a) has not expired, but the time for transferee proceeding has expired, the case, accompanied by a report containing facts in support of the transferee's liability, should be forwarded to Area Counsel through Technical Services.

4.10.13.3.3.2  (03-30-2005)
Protecting the Transferor's Statute of Limitations

  1. In attempting to collect the transferor's tax liability through a transferee case, the transferor's tax liability should always be assessed or a statutory Notice of Deficiency issued prior to the expiration of the transferor's statute of limitations unless one of the exceptions below has been met:

    1. A valid consent (Form 872, Form 872-A, etc.) to extend the transferor's statute of limitations has been obtained;

    2. A validly executed Form 2045, Transferee Agreement, has been secured in duplicate from all transferees. Managerial involvement in this determination should be documented both on Form 4318 and on the Form 895, Notice of Statute Expiration. If not secured from all identified transferees, action should be taken to prevent the statute from expiring, such as issuing a notice of deficiency to the transferor. Should there be doubt in a particular case as to whether it would be advisable to accept an agreement from the transferee as a basis for not proceeding against a dissolved corporation, advice should be requested from Area Counsel. Form 2045 does not extend the transferor's statute of limitations, but:

      1. Is an agreement between the transferee and the Commissioner, that the Commissioner agrees to discontinue action against the transferor in return for an admission by the recipient of the assets that he/she is the transferee,

      2. The transferee assumes and agrees to pay the amount of any and all Federal income taxes finally determined or adjudged as due and payable by the transferor, to the extent of such transferee's liability at law or in equity,

      3. The transferee will not, in the absence of the prior written consent of the Commissioner, sell, transfer, or assign without adequate consideration all or any substantial portion of their assets, and

      4. In the event of a corporate transferee, the agreement will be accompanied by a copy of the minutes of the corporate board of directors evidencing authorization of such agreement.

    3. The transferor has an indefinite statute of limitations (i.e., judicially determined fraud - IRC section 6501(c), no returns filed by the transferor, etc.).

  2. If a deficiency in tax is determined in the case of the transferor and the statute of limitations has expired, the deficiency should be asserted against the transferee(s) within the period of limitations applicable to him/her.

  3. Although it is unlikely that the Service will be able to collect from the transferor, it is better to proceed against the transferor in the interest of protecting the Government and eliminating a possible defense of the transferees because of two required elements of transferee liability:

    1. The possibility always exists that the transferor may have some assets in its name somewhere, which may render the transferor solvent, after the Service has permitted the transferor's statute to expire.

    2. One element of the Service's case against the transferee is that it exhausted reasonable collections efforts against the transferor. Issuing a notice to the transferor helps to establish this element.

4.10.13.3.3.3  (03-30-2005)
How State Corporate Dissolution Law Affects an Examination

  1. Transferee situations are very prevalent with dissolved corporations. If the corporation has been dissolved, there may be no assets against which to collect any proposed assessments. In that event, it may be necessary to utilize transferee liability provisions of IRC section 6901 to collect the corporate liability. A transferee case will be developed concurrently with the corporate examination if the elements needed to establish a transferee case are present. Otherwise, the examiner may consider limiting the scope of the examination. Also see IRM 4.11.52 and IRM 5.17.14.3 for additional information.

  2. Federal law, not state law, sets the statute of limitations on assessment and collection of federal taxes for transferee liability cases. State corporate dissolution law does not shorten the assessment limitations period provided by IRC section 6501. State law may, however, adversely affect the capacity of a dissolved corporation or its last board of directors to represent the dissolved corporation or to act on its behalf. This will affect the corporation's ability to extend the statute of limitations, to agree to tax liabilities or to litigate corporate liabilities.

  3. State corporate dissolution law governs how a corporation may dissolve. The state law may provide a specific time period for a dissolved corporation to wind up its affairs. Some states have a specific period in which to wind up affairs, while others do not. Only the individuals named in the applicable state law are authorized to act for the dissolved corporation and only during the winding up period. Such appointment may divest others (the officers prior to dissolution) of authority to act on behalf of the corporation. A consent must be executed by the authorized officer of a dissolved corporation on or before the last date of the winding up period in order to be valid and to hold the period of limitations open after the end of the winding up period.

  4. Caution should be exercised in obtaining waivers of restriction on assessment and extensions of the statutes of limitations in dissolved corporation and transferee cases. Examiners should not rely on any such agreements without the approval of Area Counsel.

  5. The state law which governs the corporate dissolution is the law of the state in which the corporation was organized. For example, if a corporation has its offices in Florida, does business entirely in Florida, was examined by the IRS in Florida, but was organized under Delaware law, authority to execute a consent should be tested under Delaware law, not Florida law.

  6. Examiners should consult the applicable state corporate dissolution law and identify which individuals (corporate officers, board of directors, etc.) are legally authorized to act for the dissolved corporate entity. Area Counsel may be contacted to request an opinion on who is authorized to act for the corporation.

  7. The examiner will also ensure that the individuals authorized to represent the dissolved corporation have been appointed to these duties by the corporation. Documentation will be obtained to satisfy this requirement and will be attached to any consent or waiver that the authorized individuals sign. A provision should be added below the signatures of the appointed individuals stating their title (i.e., "trustee of X corporation, a dissolved corporation " ). A provision should also be added that the corporation has dissolved, but is continuing as a corporate body under (name the section of state law).

  8. The corporation and it's authorized officers/directors may perform the following acts up to the end of the winding up period:

    1. Execute a valid extension of the statute of limitations (i.e., Form 872, Form 872-A, etc.);

    2. Execute a valid assessment agreement (i.e., Form 4549, 870, etc.). Otherwise the corporation will be unable to agree to the adjustments; and

    3. Institute litigation on behalf of the corporation.

  9. Precautions that should be taken in obtaining waivers of restriction on assessment and extensions of the statute of limitation in transferee and dissolved corporation cases.

    1. Obtain the transferee's agreement to the liability prior to the expiration of the transferor's limitation period, if at all possible;

    2. Clearly explain (and document) the effect of executing a Form 2045, Transferee Agreement; and

    3. Clearly explain (and document) the extent of a transferee's monetary liability.

  10. Some state corporate dissolution law provides that the dissolution of a corporation may be revoked within stated periods. If this occurs, this may affect the authority of the corporation or it's directors. Examiners should always inquire if a revocation of dissolution has occurred.

  11. IRC section 6901 is only applicable to income, estate, and gift taxes. Transferee liability procedures are not available to employment, excise, and other types of taxes in the Code unless they are involved in the liquidation of a corporation, partnership, or upon the reorganization of a corporation pursuant to IRC section 368(a). A liquidation is deemed to have occurred if the business entity has ceased to do business and the assets of the entity have been distributed to the owners.

4.10.13.3.3.4  (03-30-2005)
Consents to be Used in Mergers and Consolidations

  1. When a corporation is dissolved pursuant to state laws in a merger or consolidation proceeding, the successor corporation is not a transferee. The new or surviving corporation assumes primary liability for the debts of the merged or consolidated corporation. Action to assess the primary liability against the new/surviving corporation should be taken within the statutory period of limitations for assessment against the merged or consolidated corporation. If the period of limitations needs to be extended in order to make this assessment, Form 872 or Form 872-A must be executed by the new/surviving corporation before the expiration of the period of limitations for assessment against the merged or consolidated corporation. The corporate name on Form 872 or Form 872-A will be completed and signed as: " B Corporation, Inc., Successor in interest to A, Inc." .

  2. The examiner should ensure that the successor corporation is solely responsible for the liabilities of the dissolved entity. Many merger and consolidation agreements allocate some or all of the liabilities to other parties, including the sellers, with respect to the dissolved entity. Documents verifying the terms of sale should be scrutinized where possible to resolve any discrepancies.

4.10.13.3.4  (03-30-2005)
Administrative Procedures

  1. If the transferee case is originated through a related examination, the examiner will initiate control of the transferee examination. The transferee will be controlled using a "dummy" TIN on non-master file. Form 5354, Examination Required Non-Masterfile, will be completed in the following manner:

    1. Items 1 - 5 will contain the transferee's name, with "Transferee " inserted at the end, and address information;

    2. Item 6 will contain the transferee's TIN with a "-D" to indicate the "dummy" TIN;

    3. Items 7 and 8 will contain the transferor's tax period and form number;

    4. Item 9 will contain the transferee statute of limitations;

    5. Item 13 will contain the transferor's non-master file MFT;

    6. An "X" will be inserted in Item 14;

    7. Items 15, 17, 19 and 20 will be completed with the appropriate codes.

  2. PSP will initiate non-master file controls on all transferee cases referred from the Collection function.

  3. Each individual or entity which is a transferee will have a separate case file. A Form 895, Notice of Statute Expiration, will be attached to the transferee case file for each tax period. Form 895 will be completed with the transferee's name as transferee and taxpayer identification number. The return form and taxable year or period will be that of the transferor. If the transferee case was originated as referral from Collection function, the transferee statute of limitations will be computed by reference to an IMFOL-T or M on the transferor, as no returns will be contained in the file from Collection.

4.10.13.3.4.1  (03-30-2005)
Developing the Elements of a Transferee Case

  1. If the transferee case was received from Collection, the examiner will satisfy his/herself that all of the elements required in a transferee case have been documented by the RO on Form 3031. If the elements required, as outlined earlier, have not been documented, the examiner will contact the transferee (and if needed, the transferor), to interview and obtain additional documentation to support the elements required in the transferee case.

  2. If a transferee case is initiated during the examination of a transferor, the examiner will develop the elements required in a transferee case and obtain documentation to support each of the elements. The transferee will be advised that they are under examination as a transferee. An interview with the transferee may need to be scheduled and conducted in order to develop all elements and to obtain supporting documentation.

  3. The examiner will charge his/her time to activity code 812 - detail to the Collection function.

4.10.13.3.4.2  (03-30-2005)
Transferee Waivers

  1. When all of the elements have been fully developed and documented, the examiner will prepare the following waivers, solicit an agreement and payment from the transferees, and hold a closing conference:

    1. Form 870, Waiver of Restrictions on Assessment and Collection (for income tax cases), or Form 2504, Agreement to Assessment and Collection (for employment or excise tax), modified with special language, should be used to solicit an agreement from the transferee for the amount of the transferor's tax, penalties and interest. The waiver will be completed as follows:

      1. The name and address block will be completed with the name of the transferee as transferee;

        Example:

        Joe Smith, Transferee

      2. The social security or employee identification number will be that of the transferee;

      3. The tax period ended, tax, and penalties blocks will be completed with the tax period and unpaid balance of the transferor's tax and penalties. For transferee cases originated from an examination, the amounts will be taken from the examination report net of any payments. For transferee cases referred from Collection, a transcript of account will be obtained using command code IMFOL-T and will be analyzed by summarizing the total amount of tax (net of any payments) and each penalty for each tax period. These totals will be inserted on the waiver (these amounts plus interest should reconcile to the modified balance per the IMFOL-T). An index of all tax modules available will be obtained using command code IMFOL-I to ensure that all tax periods with an outstanding tax are included on the waiver; and

      4. A special paragraph will be added to the remarks section of Form 870 or to the reverse side of Form 2504. Refer to later in this section for the appropriate paragraph to insert. If the value of the assets transferred are less than the transferor's unpaid liability, the transferee's liability is limited to the value of the assets transferred. A special paragraph with language for the limited liability will be used. In this case, Form 870 will reflect the total transferor's tax and penalty liability, but the paragraph will state the amount to which the liability is limited.

    2. Form 2045, Transferee Agreement, will be solicited. By signing this form, the transferee admits liability as a transferee of assets received from the transferor, and assumes and agrees to pay the tax liability of the transferor. The government is then relieved of the burden of proof regarding the transferee liability. To protect the government's interest, solicit Form 2045 from each transferee. Form 2045 may be obtained from only one transferee provided that the assets received by the transferee are sufficient in amount to cover the total transferor's liability. If the transferee is a corporation, a copy of the minutes of the board of directors authorizing an officer to enter into this agreement should be attached to this form.

4.10.13.3.4.3  (03-30-2005)
Transferee Case File and Report

  1. Each transferee should be a separate case file, as it is separate and distinct from the transferor examination. Whenever the transferee's name is written in the file, it should have the title "Transferee" after it to distinguish it from an income tax examination of the same entity.

  2. Form 4665, Report Transmittal, should set forth all necessary facts of a confidential nature. This will include a clear statement of the present ability of the transferor and each transferee to pay, with names, addresses, amounts and nature of property held by each that may be subjected to use in payment of the tax.

  3. Each transferee file will contain a transferee report, which is prepared in memorandum form. The memorandum will be very detailed if the case if unagreed. It will list the name, address, and TIN of the transferee and the transferor. The memorandum will contain the following:

    1. A list of all of the transferor's tax periods and the respective unpaid tax liabilities and penalties;

    2. How the transferor's unpaid tax liability was determined (i.e., tax returns that were filed but the balance due was unpaid, income tax examination, etc.);

    3. Whether the transferee is a transferee at law or in equity;

    4. A complete background containing the facts and reasons for recommending the transferee action, with reference to the documentation used to support the facts;

    5. A list of the elements required to support the Government's burden of proof and how they have been met. The documentation that supports each element should be referenced;

    6. An analysis that lists all of the transferor's assets prior to insolvency and their disposition. It will include a description of each asset, its fair market value at the date of transfer, the date each asset was disposed of, and who received the assets;

    7. How insolvency and the date of insolvency were determined;

    8. Information relating to Collection function's involvement in collecting the transferor's unpaid liability; and

    9. Any attempts to conceal assets and evade payment of taxes.

  4. Documentation and workpapers will be attached to the memorandum. If it is voluminous, the workpapers and documentation will be attached to a Form 4318-A, which will be used to index the workpapers.

  5. A Form 5344, Examination Closing Record, will not be completed for the transferee case file.

4.10.13.3.4.4  (03-30-2005)
Corporate Transferor - Information to Include in the Transferee Report

  1. In cases in which the transferor is a corporation, the examiner will include the following information in the transferee report:

    1. Whether or not the corporation is insolvent, has been dissolved, or is in the process of liquidation. If the corporation has been dissolved, information should be furnished showing the date and manner of dissolution.

    2. A description, including the amount and value of the property or assets of the corporation at the time of dissolution or liquidation.

    3. Whether or not any property or assets were retained by the corporation; and, if so, a description, including the amount, present value, and location of such property or assets should be furnished, together with the name and address of the person having custody thereof. A list of the liabilities of the corporation should also be furnished. Mortgages, judgments, and other liabilities which may take priority over tax liens by reason of being recorded prior to the filing of notices of such liens as provided in IRC section 6323 should be listed separately.

    4. If subsequent to the taxable year or years being examined, any of the assets of the corporation has been transferred to another corporation through a sale or a reorganization, consolidation or merger, a description, including the value of the assets transferred, and a statement showing whether the consideration given for such assets was cash, stock or both. If both cash and stock passed as consideration, a statement of the amount of cash paid and the number of shares of stock transferred, both common and preferred, and the value of such stock at the time of transfer. A statement should also be furnished as to the present financial condition of the corporation taking over the assets, together with the address of such corporation. If the reorganization, consolidation or merger was made pursuant to a written agreement or under the provisions of a State statute, a copy of such agreement should be secured and made a part of the report or reference made to the State statute.

    5. Whether the liabilities of the corporation were assumed by any other corporation or person; and if so, a copy of the agreement under which such liabilities were assumed should be furnished.

    6. The full name of each stockholder who received assets of the corporation at the time of liquidation, the present address of each of such stockholders, and the number and par value of the shares of stock held by each at the time of liquidation.

    7. Whether the stockholders of the corporation received both cash and other property in the liquidation of the corporate assets. If so, the amount of cash received by each stockholder and a description, including the amount and value of the property received by each stockholder and the present financial condition of each should be furnished.

    8. Whether any assets of the corporation were transferred without adequate consideration to any other corporation or person. If so, a complete statement of all the facts and circumstances pertaining to such transactions, particularly the name, present address, and financial status of each transferee, should be furnished, together with a description of the assets transferred, the consideration paid therefor, and the value of the assets received by each transferee.

    9. A statement should also be furnished showing the name and present address of each stockholder who has not paid in full the amount of his/her subscription to the capital stock of the corporation and the amount owing thereon.

    10. State specifically the source or sources from which the information was obtained; that is, whether from the books and records of the corporation concerned, from public records, or from statements of former officers, stockholders, employees, etc. Copies of the records should be obtained if they are not too voluminous.

4.10.13.3.4.5  (03-30-2005)
Deceased Transferor - Information to Include in the Transferee Report

  1. In cases in which the transferor is deceased, the examiner will include the following information in the transferee report:

    1. The correct name, late address, and the date of death of the decedent, the full name and present address of the executor or administrator, and the title or name and the location of the court having jurisdiction of the estate; also whether or not the decedent left a will, and, if so, a copy thereof.

    2. Whether a proof of claim for the tax referred to has been filed and, if so, the date of filing and with whom it was filed.

    3. A copy of the inventory of the property and assets or any similar document filed by the executor or administrator with the court.

    4. Whether complete distribution has been made of all of the property and assets of the estate, and, if so, a copy of the report of the executor or administrator or of the final order or decree of the court showing the distribution in kind or otherwise of the property and assets of the estate. The date of such report, order, or decree should be given.

    5. Unless clearly and fully shown by the information called for above, a description, including the actual amount or value in money, of all of the property and assets received by each distributee, the dates such property and assets were received and whether received as a specific bequest or whether the distributee is an heir at law or a residuary legatee, together with the name and present address and financial status of each distributee.

    6. A description, including the amount or value in money, of the undistributed property and assets, if any, remaining in the hands of the executor or administrator as of the date of the report.

    7. If the executor or administrator has been discharged, or if the estate has been closed, a copy of the final order or decree of the court discharging him/her or closing the estate should be furnished, unless this is contained in or is clearly shown by any other documents called for herein. The exact date of such order or decree should be shown thereon or in the report.

    8. State specifically the source or sources from which such information was obtained; that is, whether from the books and records of the taxpayer, from public records, or from a statement of persons having knowledge of the facts, such books and records being identified and the pages or folio numbers thereof indicated. Copies of the records should be obtained if not too voluminous.

4.10.13.3.4.6  (03-30-2005)
Closing an Unagreed Transferee Case

  1. If the transferee case is unagreed, the examiner will prepare the 30-day letter using Letter 955, modified as necessary.

  2. Special language will be inserted as the opening paragraph to Letter 955, depending on the circumstances of the case.

4.10.13.3.4.7  (03-30-2005)
Closing an Agreed Transferee Case

  1. If the transferee case is agreed, the case will be forwarded to Technical Services for special handling. Technical Services will prepare Form 1296, Assessment Against Transferee or Fiduciary, see IRM 4.8.8, Technical Services, Miscellaneous Responsibilities. Technical Services will also complete Form 10904, Request for Record Deletion from AIMS/ERCS, using disposal code 28 and include the form inside the case file. Technical Services will then forward the case to Case Processing for assessment.

4.10.13.3.4.8  (03-30-2005)
Closing a Transferee Case with less Than Six Months Remaining on the Transferee Statute of Limitations

  1. If the transferee examination is within six months of the statute expiration date or if the transferee failed to file a valid protest to the 30-day letter, the transferee case will be forwarded to Technical Services for issuance of a Statutory Notice of Transferee Liability.

4.10.13.3.5  (03-30-2005)
Liability of Transferee for Interest

  1. Once it is established that the value of the assets transferred exceeds the transferor's tax liability plus interest, the courts have generally held the transferee liable for interest in the same manner as the transferor would have been. In a similar situation involving the transferee of a wholly owned corporation, the transferee is liable for interest from the date on which the corporate tax was due.

  2. This points out the distinction between the transferee's liability for interest, depending on whether the value of the asset transferred was more or less than the original liability. Although the liability of the transferee arises under state law, the amount of the creditor's claim should be determined under the Internal Revenue Code as long as the value of the transferred assets was more than enough to satisfy the liability plus interest. Therefore, the generally accepted rule is that the transferee will be liable for interest in the same manner as the transferor would have been as long as the value of the transferred assets exceeds the amount of the original liability plus interest.

4.10.13.3.5.1  (03-30-2005)
Limited Liability Where the Value of the Assets Transferred Is Less Than the Transferor's Liability

  1. At the present time, the transferee's liability for interest has not been clearly established where the value of the transferred assets is less than the original tax liability. The Tax Court stated that where the transferred assets are insufficient to pay the liability, interest is not allowed on the tax liability itself because transferee liability is limited to the amount transferred. However, interest can be charged against the transferee for the use of transferred assets, and since this involves the extent of transferee liability, it is to be determined by state law.

  2. Under this theory, the United States is in much the same position as a private creditor under state law. The transferee is liable for interest only from the date the statutory notice of deficiency is sent to the transferee and he/she becomes aware of the debtor-creditor relationship between him/herself and the United States. This appears to be the prevailing view, especially if constructive fraud is proved. Some jurisdictions hold the transferee liable for interest from a prior date, such as the date of transfer, if there was actual fraud. Many states will not hold the transferee liable for interest prior to the date of notice of his/her liability unless the transferee had actual knowledge of the fraud.

  3. In summary, if the transferee had no knowledge of the fraud, he/she will often be liable for interest from the date he/she received notice. Otherwise, he/she may be liable from an earlier date, such as the fair average date of receiving, or the date of transfer. Contact Area Counsel for the applicable state law.

  4. When closing a transferee case in which the assets transferred are less than the transferor's liability, Form 3198 should be annotated: " Transferee Case - Limited Liability" .

4.10.13.3.6  (03-30-2005)
Transferee Letters

  1. The group prepares the preliminary 30-day letter for transferee cases. Technical Services prepares the statutory notices of transferee liability and statutory notices of fiduciary liability in all transferee cases.

  2. The 30-day letter, the statutory notice of transferee liability and the statutory notice of fiduciary liability all have three different parts:

    1. The letter to the transferee, which is modified by a paragraph for transferee/fiduciary liability. The letter to be used as the 30-day letter is Letter 950(P). The letter to be used as a statutory notice of transferee/fiduciary liability is Letter 902(P). Letter 1384(P) is the statutory notice of transferee liability for transferors in bankruptcy and receivership. See subsection below for the opening paragraphs to use.

    2. The attachment to the letter, lists the name, address, TIN, tax, penalty and interest liability of the transferor. It also lists the name, address, and TIN of the transferee followed by statements as to the extent of the transferee's liability and how the transferee's liability arose. See subsection below for the paragraphs to use and how to prepare the attachment to the letter.

    3. The waiver/agreement on assessment and collection of additional tax, modified by a special paragraph for transferee/fiduciary liability. Form 870 will be used for income tax. Form 2504 will be used for employment or excise tax. Form 890 will be used for estate tax cases. Refer to subsection below for the paragraph to use to modify the waiver. The total transferor's unpaid tax and penalty liability will be inserted in the applicable blanks even if the transferee's liability is limited. If the liability is limited, the paragraphs modifying the waiver will state the amount the liability is limited to.

    4. Exhibits may be attached to the above letter package to aid the transferee in understanding why he/she is a transferee or any supporting computations. Examination reports will not be sent with preliminary (30-day) letters asserting liability against transferees.

  3. All proposed statutory notices of transferee liability will be reviewed by Area Counsel prior to issuance.

  4. No statutory notices of transferee liability will be issued for employment or excise tax. IRC section 6901 states that the liability will be assessed, paid, and collected in the same manner as in the case of the taxes with respect to which the liabilities were incurred. Since no notice of deficiency is issued to a taxpayer for employment or excise taxes, no notice of transferee liability will be issued to a transferee employment or excise taxes.

  5. If the 30-day letter or notice of transferee liability is issued for a transfer, it should be asserted in the first paragraph of the letter that the substantive liability is founded.

  6. If in an estate tax case a preliminary letter or a statutory notice is issued to a transferee, trustee, or beneficiary of property includible in the gross estate under IRC sections 2035, 2036, 2037, 2038, 2040, 2041, or 2042. It should be issued within the 3-year period provided by IRC section 6501. If such property is in trust and is includible under IRC sections 2035-2038, inclusive, in lieu of the single term "transferee" in IRM , the designation "transferee and trustee" should be inserted. If such property is insurance includible under IRC section 2042, in lieu of the single term "transferee" , the designation "transferee and beneficiary" should be inserted.

  7. If the letter to the transferee covers a deficiency for 1 year and refund due to the transferor for another year, the statutory notice statement paragraph should be revised to read as follows (unless the refund is protected by a claim filed within the statutory period prescribed for filing claims for refund):

    The overassessment shown herein will be made the subject of a certificate for the overassessment which will be applied against the tax liability of the transferor in accordance with section 6402 of the Internal Revenue Code provided a proper claim for refund has been filed by the transferor.

  8. If the transferor's liability has been judicially determined, the adjustments to net income, explanations and computations of tax should be omitted and the following type of paragraph inserted:

    The correctness of the amount of the deficiency due from John E. Doe, (address, has been determined by decision of the Tax Court of the United States, Docket No. (number).

4.10.13.3.6.1  (03-30-2005)
Opening Paragraphs in Preliminary Letters to Transferees

  1. When Letter 950 is sent to transferees, the following opening pattern paragraphs will be used in straight deficiency cases (if employment tax is involved, the words "income tax" will be changed to "employment tax" and "years" will be changed to "periods" .

    1. Income tax case pattern paragraph P-30:

      There is proposed for assessment against you the amount of ($amount), plus penalties and interest thereon as provided by law, constituting your liability a transferee of the assets of (Name, Transferor), (address), for income taxes due for the taxable year(s) ended (date of year end), as shown in the attachment to the letter.

    2. Estate tax case pattern paragraph P-31:

      We have proposed an assessment against you in the amount of ($amount), plus penalties and interest thereon as provided by law, constituting your liability as a transferee of property of the estate of (Name), (address) for estate tax, penalties and interest thereon, as shown in the attachment to the letter.

    3. Gift tax case pattern paragraph P-32:

      We have proposed an assessment against you in the amount of ($amount), plus penalties and interest thereon provided by law, constituting your liability as a transferee of property of (Name, Transferor), (address), for gift tax, penalties and interest thereon, for the calendar year(s) (year), as shown in the attachment to the letter.

    4. When Letter 950 is sent to a fiduciary regarding his/her liability under IRC section 6901 and Title 31 of the United States Code, section 3713, because he/she paid debts of distributed assets without first satisfying the tax due to the United States from the estate, one of the following opening paragraphs will be used:

      1. Income Tax Case pattern paragraph P-33:

        We have proposed an assessment against you in the amount of ($amount), plus penalties and interest thereon as provided by law, constituting your personal liability as a fiduciary of the estate of (name), (address), for income taxes, penalties and interest thereon due from (Decedent name) or (Estate), (address) for the tax year(s) ended (year end), as shown in the attachment to the letter.

      2. Estate Tax Case pattern paragraph P-34:

        We have proposed an assessment against you in the amount of ($amount) plus penalties and interest thereon provided by law, constituting your personal liability as a fiduciary for estate tax due from the estate of (name), (address), as shown in the attachment to the letter.

      3. Gift Tax Case pattern paragraph P-35:

        We have proposed an assessment against you in the amount of ($amount), plus penalties and interest thereon, as provided by law, constituting your personal liability as a fiduciary for gift tax due from John Doe, deceased, for the calendar year(s) (year), as shown in the attachment to the letter.

  2. In mixed deficiency and overassessment cases involving transferee or fiduciary liability, the opening paragraphs inserted in Letter 950 will be suitable revisions of pattern paragraphs P-30 to P-35 as shown above.

  3. If the value of the assets received by a transferee is less than the unpaid tax liability of the transferor, the opening paragraphs P-30 to P-32 will be used, but modified by the following phrase:

    ($amount) of the unpaid liability plus interest thereon provided by law constitutes your liability as a transferee of the assets of (transferor name).

4.10.13.3.6.2  (03-30-2005)
Opening Paragraphs for Statutory Notices of Transferee Liability

  1. The opening paragraph of the statutory notice of transferee liability is dependent upon the circumstances of the case. The language for the various opening paragraphs is contained in IRM 4.14.1.14.4, Statutory Notices of Deficiency.

4.10.13.3.6.3  (03-30-2005)
Attachment to the Letter for Statutory Notices of Transferee Liability

  1. The attachment to the letter is an explanation to the transferee as to where the proposed assessment originated. The attachment to the letter is divided into two parts:

    1. First is the transferor's section, which lists the name, address, and TIN of the transferor. The unpaid income tax liability and penalties for each tax period subject to transferee liability will also be listed. If the transferor has made payments to reduce the liability, the payments will be netted against the tax, penalties and interest for the earliest tax periods first. The payments will be allocated to the tax, penalties and interest previously assessed against the transferor on the basis of the ratio of the separate amounts of tax, penalties and interest to the aggregate amount assessed. The net figures will be reflected on the attachment to the letter and on the waiver. If the transferee's liability is limited, the list of the transferor's unpaid liability will reflect the transferor's total unpaid liability and will not be adjusted because of the transferee's limitation. The following statement will be placed below the listing of the unpaid liability; "Interest thereon as provided by law will be charged on the unpaid liability until it is paid in full" .

    2. Second is the transferee's section, which lists the name, address, and TIN of the transferee.

  2. The attachment to the letter will be prepared in the format, with the language, shown in IRM 4.14.1.14.4, Statutory Notices of Deficiency.

4.10.13.3.7  (03-30-2005)
Assessments

  1. Form 1296, Assessment Against Transferee or Fiduciary, will be prepared by Technical Services when an assessment is to be made against a transferee. A separate Form 1296 is prepared for each transferee for each taxable year/period of the transferor. If the value of the assets received by the transferee is less than the unpaid liability of the transferor and more than one year is involved, the transferee's liability should not be allocated to the various years. Instead, the liability should be shown as one amount on the Form 1296 for the earliest year of the transferor without identifying it with any particular year of the transferee. In limited liability cases such as these, instructions should be included on Form 1296 for computation of interest. The interest starting date and the interest rate will be annotated on Form 1296. An appropriate cross-reference should be made on the other Forms 1296, if any.

  2. If a statutory notice is issued to the transferor prior to completion of the action against the transferee(s), the return of the transferor will be forwarded at the expiration of the 90-day period for assessment if no appeal is filed, or earlier if an agreement is received. After assessment, the case file of the transferor will be sent back to the appropriate examination group to complete and associate with the transferee case.

  3. If a waiver of restrictions on assessment and collection for the entire deficiency is filed by the transferor, and no preliminary action has been taken with respect to the transferees, the case will be forwarded for assessment of the tax. After assessment, the case is returned to Examination function for appropriate action with respect to the transferee liability if the tax has not been paid by the transferor.

  4. When a preliminary action (30-day letter has been issued) has been taken against the transferor and/or transferee(s) and a waiver of restrictions on assessment for all or any part of the unpaid liability is filed by one but not all of the transferees, the agreement, together with Forms 1296, will be forwarded for assessment. The assessment will be made, the agreement and Forms 1296 will be transmitted to the appropriate group. Subsequent closing action on the case, including advice to the remaining transferees of discontinuance of transferee action, will depend on whether the transferor's tax liability has been discharged by payment.

  5. If statutory notices are issued concurrently to the transferor and transferee(s) and no petitions are filed within the 90-day period, the entire file will be sent for assessment and subsequent action to clear the accounts if the transferor's tax is paid.

  6. Technical Services will prepare Forms 1296 and forward them for assessment when a transferor's case is before the Tax Court, and the transferees fail to file petitions within 90 days after Examination issued statutory notices of liability to them. Appeals office will be informed of any payments made by the transferees.

  7. Examination function's consideration of a transferor-transferee case will not be concluded until the record shows that either the tax due from the transferor has been paid or closing action has been taken with respect to the transferor and transferees.

  8. Form 3198 should be prepared in all transferor-transferee cases, and remarks noted where applicable: "Transferee case Agreed/Unagreed, route to Technical Services." Technical Services will make the decision as to whether a transferee assessment will be made. If so, Technical Services will prepare Form 1296 with proper instructions and will send it along with the case file to Case Processing.

4.10.13.4  (03-30-2005)
Related Party Transactions (IRC 482)

  1. It is common knowledge that IRC section 482 applies to cases involving transactions with foreign related parties. In fact, the original purpose of section 482 was to assure sufficient U.S. tax would be paid when a domestic corporation sold domestically produced goods to a foreign sales subsidiary at cost or at a minimal write-up. However, while the principal target of IRC section 482 appears to have been U.S. income shifted to commonly controlled foreign entities, this section can be invoked to combat tax avoidance and to correct income distortion arising from transactions between domestic entities.

  2. The actual text of IRC section 482 is very short and concise. The regulations and court cases provide a more thorough understanding of its application. In addition to this IRM, please refer to IRM 4.11.5.

4.10.13.4.1  (03-30-2005)
Purpose and Scope of Section 482

  1. Under Treas. Reg. 1.482-1(a)(1), "the purpose of section 482 is to ensure that taxpayers clearly reflect income attributable to controlled transactions." . The intent of the provisions are to place the controlled corporation in the same position as if it were not a controlled entity.

  2. This section provides that all income, deductions, credits, and other allowances of related taxpayers may be reallocated by the Service to prevent the evasion of taxes or to clearly reflect the income of the related entities. The Service may allocate income even if tax evasion is not present if such allocation will more clearly reflect the income of the controlled interests. Treas. Reg. 1.482-1(f)(1)(i).

  3. The focus of IRC section 482 is economic reality, not motivation and purpose.

  4. The Commissioner's determination is not be overturned unless that determination is shown by the taxpayer to have been unreasonable, arbitrary and capricious.

4.10.13.4.2  (03-30-2005)
Two or More Organizations, Trades or Businesses

  1. To justify a reallocation under IRC section 482, the Commissioner must find:

    1. that there are two or more trades, business, or organizations,

    2. that such enterprises are owned or controlled by the same interests, and

    3. that the reallocation is necessary in order to prevent the evasion of taxes or to reflect properly each enterprise's income.

  2. The phrase "two or more organizations, trades or businesses " has caused some concern in determining the applicability of section 482. "Organization includes an organization of any kind, whether a sole proprietorship, a partnership, a trust, an estate, an association, or a corporation . . ." Treas. Reg. 1.482-1(i)(1).

  3. A shareholder's transactions with his controlled corporation may be subject to IRC section 482. In Fegan v. Commissioner, 71 TC 791 (1979), the taxpayer argued the allocation of additional rental to him from his controlled corporation was improper because he was an individual and not an organization, trade, or business as referred to in section 482. The court was not convinced, stating, "Petitioner leased to Enterprises all the real property, equipment, and furnishings needed to operate a 100-room motel. On the basis of these facts, we consider the rental business within the meaning of Section 482."

  4. It is the position of the Service that a shareholder/employee who receives a salary for services rendered is engaged in a trade or business for purposes of IRC section 482. Rev. Rul. 88-38, 1988-1 CB 246.

4.10.13.4.3  (03-30-2005)
Specific Situations in Which IRC Section 482 Could Be Applied

  1. The following is a summary of various situations in which an IRC section 482 issue could be raised. Neither this summary nor the citations furnished are meant to be all inclusive.

4.10.13.4.3.1  (03-30-2005)
Loans or Advances - Treas. Reg. 1.482-2(a)

  1. Is an arm's length interest rate charged? If either IRC section 483 or IRC section 7872 applies, it should be used as the primary position. If there is a dispute over whether one of these applies or if it is unclear, IRC section 482 should be raised as an alternative position.

  2. When considering loans between two related entities, the Service is not necessarily bound to the position of "imputing" interest income under IRC section 482. Under certain circumstances, the Service may use section 482 to reallocate interest expense claimed by one entity to its affiliate. In Kahler Corp. V. Commissioner, 486 F.2d 1 (1973), revg. 58 TC 496 (1972), the common parent of an affiliated group borrowed funds from third party lenders. Subsequently, the parent reloaned some of its borrowed funds to two of its subsidiaries interest free. The affiliated group did not file a consolidated return. The parent was in a high tax bracket and thus, received a significant benefit from the interest expense it claimed. On the other hand, both of the two subsidiaries were in much lower tax brackets and would not have derived much benefit.

  3. Similarly, in Latham Park Manor, Inc. v. Commissioner, 69 TC 199 (1977), in his concurrence, Judge Scott stated:

    In economic reality, MIC was the true borrower. . . Making a proper allocation of the interest deductions and amortized loan costs (which is the substance of the adjustment make by respondent in the notice of deficiency) fully eliminates the tax avoidance here occasioned by the relationship of the parties. . .

4.10.13.4.3.2  (03-30-2005)
Performance of Services - Treas. Reg. 1.482-2(b)

  1. In S. W. Haag, 88 TC 604, a physician assigned his interest in a medical partnership to his professional corporation. Although the doctor provided medical services to the corporation, he received either no salary or minimal salary for the years in question. The court stated, "Petitioner would not have agreed to work for no compensation if he had bargained at arm's length with an uncontrolled entity." and upheld the government's section 482 adjustment, which was "the difference between the amount of compensation petitioner would have received in each year absent of incorporation and the amount he actually received."

  2. In D. F. Keller, 77 TC 1014, in determining the applicability of section 482 to a pathologist's compensation, his total compensation (salary, pension plan contributions, and medical benefits) was compared to what the petitioner would have bargained for in an arm's-length transaction with an unrelated party.

  3. Due to employment tax considerations, it appears when inadequate compensation is paid to a shareholder/employee, consideration should be given to whether loans to the shareholder should be recharacterized as compensation instead of treating them as dividend distributions. It would appear it may be in the government's best interest to raise section 482 as the primary position whenever the C corporation has a net operating loss or does not have sufficient earnings and profit.

  4. In J. J. Haber, 52 TC 255, a S corporation made loans to one of its shareholder/employees over several years but reduced the shareholder/employee's salary by the amount of the loans. The loans were recharacterized as compensation for services. Although raising a section 482 issue on compensation from an S corporation will usually have a wash effect on income tax, it should be considered when the shareholder otherwise has no earnings subject to FICA tax.

  5. The Supreme Court stated in Lucas v. Earl, 281 U.S. 111 (1930) income is taxable to the one who earns it, regardless of whether than person made a legally binding contract to have it paid to another. The fruit may not be "attributed to a different tree from that on which it grew."

  6. In V. Borge, 26 TCM 816, Victor Borge, the pianist-comedian, made a contract with his controlled corporation to provide entertainment services. IRC Section 482 was used to allocate income to Borge individually.

  7. In W. H. Bell, III, 45 TCM 97, three physicians formed a professional corporation and a separate S corporation. The S corporation earned income from providing X-ray services to the professional corporation. IRC Section 482 was used to allocate income from the S corporation to the C corporation. The income allocated was then treated as dividend distributions from the C corporation to its shareholders. If an existing business is transferred to multiple corporations, the examiner, in addition to considering section 482, should consider the applicability of sections 269 and 1551.

  8. In R. Rubin, 72-1 USTC 9440, payments by Corporation A to Corporation B were allocated under section 482 to the shareholder of Corporation B who had performed the management services for Corporation A. The taxpayer's services constituted a trade or business separate from his interest in Corporation B.

  9. P. W. Ach, 42 TC 114, the taxpayer sold her successful dress shop to her son's insolvent corporation for less than adequate consideration. Although the taxpayer continued to provide significant managerial services to the business, she was not remunerated for her services. The court upheld the Service's use of IRC section 482 to allocate 70% of the profits of the dress shop to the taxpayer. The court held the parties had not dealt at arm's length and the sole purpose for the transfer of the dress shop was for the corporation to utilize net operating losses it would have otherwise lost.

4.10.13.4.3.3  (03-30-2005)
Use of Tangible Property - Treas. Reg. 1.482-2(c)

  1. A shareholder's rental of a commercial building to his/her controlled corporation for no rent or for less than fair rental is subject to IRC section 482. D. A. Peck, 43 TCM 291. See also, Fegan v. Commissioner, 71 TC 791; R. Cooper, 64 TC 476; J. J. Thomas, 46 TCM 974.

  2. This may be particularly abusive in situations where the corporation has a net operating loss. To the extent the shareholder has an allowable rental loss after applying section 482 and any other relevant provisions of the Code, IRC section 469 should be considered to disallow any passive activity loss.

  3. A partnership's rental of a building to a related corporation for no rent or for less than fair rental is also subject to IRC section 482. R. A. Boyer, 58 TC 316.

4.10.13.4.3.4  (03-30-2005)
Transfer or Use of Intangible Property - Treas. Reg. 1.482-4

  1. Per regulation 1.482-4(b), intangible property for purposes of IRC section 482 includes:

    1. Patents, inventions, formulae, processes, designs, patterns;

    2. Copyrights and literary, musical, or artistic compositions;

    3. Trademarks, trade names, or brand names;

    4. Franchises, licenses, or contracts;

    5. Methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data;

    6. Other similar items.

4.10.13.4.3.5  (03-30-2005)
Transfer of Tangible Property - Treas. Reg. 1.482-3

  1. There are numerous cases involving the sale of goods between a controlled domestic corporation and a controlled foreign corporation. A referral to International Specialists is required in these cases.

  2. In accordance with Rev. Rul. 69-630, 1969-2 CB 112, (as modified by 1999-2 I.R.B. 41) in the cases of a bargain sale between two corporations owned by the same shareholder, the income of the seller will be increased to reflect the arm's-length price, and the basis of the property to the purchaser will be increased by a like amount. Additionally, the amount of the increase will be treated as a distribution by the selling corporation to the shareholder and as a capital contribution by the shareholder to the purchasing corporation, unless the transaction giving rise to the section 482 allocation did not have as one of its principal purposes the avoidance of income tax. Rev. Proc. 65-17, 1965-1 CB 833.

  3. The sale of property by a shareholder to his controlled corporation is subject to section 482. C. O. Anderson, 35 TCM 101. The sale of land by a partnership to its controlling corporate partner is also subject to IRC section 482. Aladdin Industries, 41 TCM 1515.

  4. Following a disproportionate distribution of property from their partnership, the partners contributed the land to a charitable organization. IRC Section 482 was applied to allocate the charitable contributions among the partners consistent with the percentage interests in the partnership. R. M. Dolese, 82 TC 830.

  5. Similarly, in Northwestern National Bank of Minneapolis, 556 F.2d 889 (1977), the Service successfully reallocated to a wholly-owned subsidiary a charitable deduction claimed by the parent consisting of assets acquired from the subsidiary by means of an upstream dividend. The subsidiary in this case acquired 10% of the stock of a company for a cost of $100,000. Over time the fair market value of the stock rose to $800,000. After consideration of various alternatives, the subsidiary declared a dividend to its 100% corporate parent of the stock. Within two weeks of receiving its "dividend " , the parent donated the stock to a charitable foundation. The taxpayer argued IRC section 482 was inapplicable to a transaction that originated as a dividend distribution. In addressing this, the court stated:

    There is nothing in the language of section 482 or its corresponding regulations that is inconsistent with applying section 482 to transactions between subsidiary corporations that might not occur in similar form between unrelated taxpayers. . . . The purpose behind the dividend distribution was to obtain a tax advantage not available in an arm's length transaction. This transaction was made possible solely on the basis of appellant's relationship with and control of Bank Building Company, and the end result was a distortion of the respective net income of . . . .

4.10.13.4.3.6  (03-30-2005)
Otherwise Nonrecognized Gains or Losses - Treas. Reg. 1.482-1(f)(1)(iii)

  1. Section 482 controls when it conflicts with section 351 as long as the Commissioner does not abuse his discretion to reallocate income and expenses. F. L. Rooney, 62-2 USTC 9598. In footnote 4, the court in Aladdin Industries, 41 TCM 1515, stated: "It has been routinely held, absent an abuse of discretion by the Commissioner, section 482 will override specific non-recognition provisions of the code. National Securities Corp. v. Commissioner, 137 F.2d 600 (3d Cir. 1943), cert. denied 320 US 794 (1943); Central Cuba Sugar Co. V. Commissioner, 198 F.2d 214 (2d Cir. 1952), cert. denied 344 US 874 91952) . . ."

4.10.13.4.4  (03-30-2005)
Burden of Proof and Issue Development

  1. There is generally acknowledged a three-tiered approach to the burden of proof in IRC section 482 cases:

    1. If the notice of deficiency is clear that the IRS is relying on section 482, the burden is on the taxpayer to establish the allocation is unreasonable, arbitrary, or capricious.

    2. If section 482 is not raised until after the notice of deficiency but the taxpayer is notified far enough in advance of trial so as not to prejudice him, the burden shifts to the IRS to establish all elements in order to support the allocation under section 482.

    3. If section 482 is raised too late to allow the taxpayer sufficient warning, the IRS cannot rely on section 482 at all.

  2. See generally CAL-FARM Insurance Co. v. United States, 86-2 USTC 9717; Achiro v. Commissioner, 77 TC 881 (1981). In CAL-FARM, the taxpayer tried to convince the court it had not been given adequate notice of the reliance on section 482 and therefore, the Service should be prohibited from relying on it. The court found in favor of the Service, noting the "first line of the text of the notice [statutory notice of deficiency] refers to an attached examination report prepared by an Internal Revenue Service revenue agent. The revenue agent refers to section 482 at page 3 . . ." . Therefore, it is important for examiners to ensure reports clearly reflect the Service's reliance on IRC section 482, even if this is an alternative position. In so doing, the burden of proof will remain with the taxpayer to show the Service's proposed adjustment is "unreasonable, arbitrary, and capricious " .

  3. It is important to note IRC section 482 applies only at the discretion of the Commissioner. Treas. Reg. 1.482-1(a)(3) states "Except as provided in this paragraph, section 482 grants no right to a controlled taxpayer to apply its provisions at will, nor does it grant any right to compel the district director to apply such provisions." Thus, taxpayers are prohibited from invoking the provisions of section 482 once they are under examination.

4.10.13.4.5  (03-30-2005)
Examination Reports and Processing

  1. To accomplish tax parity, the Service may allocate items of income or expense among controlled taxpayers. The initial adjustment which ordinarily increases the income of one or more members and creates a decrease in income of related members is a "primary adjustment" . The corresponding decrease in income of the other member is the "correlative adjustment " .

  2. When an adjustment is made to the primary taxpayer under IRC section 482, the concurrent examination of the income tax return(s) of the correlative taxpayer(s) should ordinarily be made.

4.10.13.4.5.1  (03-30-2005)
Required Elements

  1. A statement will be made in the report to the primary taxpayer to the effect that:

    1. Separate examination reports have been prepared reflecting the IRC section 482 correlative adjustment with respect to the correlative taxpayer.

    2. The correlative adjustment is deemed to have been made in instances where the correlative adjustment has no effect on the income tax liability of the correlative taxpayer.

  2. The correlative adjustment should not be made until the primary adjustment has been resolved. Per Treas. Reg. 1.482-1(d)(2), the primary adjustment may be resolved in one of the following ways:

    1. The assessment of tax following execution of Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment.

    2. Acceptance of a Form 870-AD, Offer of Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Assessment of Overassessment.

    3. Payment of the deficiency.

    4. Stipulation in the Tax Court.

    5. Final determination of tax liability by offer-in-compromise, closing agreement, or court action.

  3. To provide uniform treatment of all IRC 482 cases, agreed or unagreed, reports on the primary taxpayer and the correlative taxpayer should be prepared concurrently; kept together (not separate) and transmitted to the next function (i.e., Technical Services, Appeals Office, or campus processing center).

  4. In cases with no tax effect of a correlative adjustment (foreign entity, loss entity, etc.), the examiner should make a statement in the preliminary statement to the effect that the correlative adjustment is deemed to have been made when and if the adjustments are agreed to and assessment has been made or deficiency has been paid. It is important that this statement included in all reports in order that the taxpayer to which the correlative adjustments apply may not escape the effect of these adjustment in the event of a subsequent exam or carryback of losses or credits or other events which do have a tax effect.

  5. To ensure that overpayments resulting from the correlative adjustments are not scheduled and refunded to the taxpayer, the examiner will note Form 3198 accordingly.


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