An Update on the IRS's War Against Midco Transactions: Some Courts Hold That Taxpayer Knowledge Is Irrelevant When the IRS Uses State Constructive Fraud Theories to Prove Transferee Liability

By Bryan C. Skarlatos & Caroline Rule
Journal of Tax Practice & Procedure
June - July 2016 Edition

Last year, we wrote about the IRS’s efforts to recover unpaid taxes after a so-called “Midco” corporate transaction, under a theory of transferee liability. We discussed how courts had focused on whether the selling shareholders of a target corporation in a Midco transaction knew or should have known that the whole Midco transaction would result in the target corporation’s tax liability remaining unpaid. Such actual or constructive knowledge justified courts in applying the judicial doctrine of “substance over form” to recast the Midco transaction as a de facto liquidating distribution to the shareholders. Since then, the IRS has become more aggressive when applying states’ versions of the Uniform Fraudulent Transfer Act (“UFTA”) to recover from Midco transferees and has succeeded in recovering in some cases without having to prove knowledge, or even reason to know, on the shareholders’ part that the Midco transaction would result in unpaid corporate taxes.