PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
ALBERT J. STARNES,
Petitioner-Appellee,
v.
No. 11-1636
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellant.
ESTATE OF SALLIE C. STROUPE,
Petitioner-Appellee,
v.
No. 11-1706
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellant.
ANTHONY S. NAPLES,
Petitioner-Appellee,
v.
No. 11-1712
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellant.
2 STARNES v. CIR
RONALD D. MORELLI, SR.,
Petitioner-Appellee,
v.
No. 11-1714
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellant.
Appeals from the United States Tax Court.
(Tax Ct. Nos. 5199-09; 5200-09; 5202-09; 5201-09)
Argued: March 22, 2012
Decided: May 31, 2012
Before NIEMEYER, DAVIS, and WYNN, Circuit Judges.
Affirmed by published opinion. Judge Davis wrote the opin-
ion, in which Judge Niemeyer joined. Judge Wynn wrote a
dissenting opinion.
COUNSEL
ARGUED: Francesca Ugolini Tamami, UNITED STATES
DEPARTMENT OF JUSTICE, Washington, D.C., for Appel-
lant. Robert Leon Widener, MCNAIR LAW FIRM, PA,
Columbia, South Carolina, for Appellees. ON BRIEF:
Tamara W. Ashford, Deputy Assistant Attorney General, Gil-
bert S. Rothenberg, Kenneth L. Greene, UNITED STATES
DEPARTMENT OF JUSTICE, Washington, D.C., for Appel-
lant.
STARNES v. CIR 3
OPINION
DAVIS, Circuit Judge:
In Commissioner v. Stern, 357 U.S. 39 (1958), the Supreme
Court held that if a person is the "transferee" of a taxpayer’s
assets, the "existence and extent" of that transferee’s liability
for unpaid taxes the taxpayer owed prior to the transfer is
determined by state law, not federal law. Id. at 45. This case
requires that we apply Stern to a transaction the Commis-
sioner of Internal Revenue characterizes as an "intermediary
transaction tax shelter."
Albert J. Starnes, Ronald D. Morelli, Sr., Anthony S.
Naples and Sallie C. Stroupe (collectively, the "Former Share-
holders") worked at Tarcon, Inc., a trucking company, for
over forty years, and together purchased the company in
1972, each holding a 25 percent stake. In 2003, they decided
to sell their interests and retire. After consulting with their
real estate broker, accountant and attorneys, they sold Tar-
con’s only remaining asset (a warehouse) to one company,
ProLogis, Inc., and sold their Tarcon stock to another com-
pany, MidCoast Investments, Inc. (together with its affiliates
MidCoast Credit Corp. and MidCoast Acquisitions Corp.,
hereinafter "MidCoast"). MidCoast contractually agreed that
it would operate Tarcon as a going concern and cause Tarcon
to pay the approximately $880,000 in federal and state corpo-
rate income taxes Tarcon owed on the income the company
received from selling the warehouse. Having become the sole
stockholder of Tarcon, however, within a few weeks Mid-
Coast sold Tarcon to another company, which transferred Tar-
con’s cash to an offshore account. Tarcon’s 2003 tax returns
claimed certain losses that purported to offset entirely the tax
liability it incurred on the income from the sale of the ware-
house. When the Internal Revenue Service ("IRS" or "the
Commissioner") audited the federal return, it disallowed those
losses and thereby imposed the tax liability, but Tarcon never
paid the taxes.
4 STARNES v. CIR
Unable to secure payment from Tarcon, the IRS turned its
efforts toward the Former Shareholders, asserting they were
themselves liable, as transferees, for Tarcon’s unpaid taxes.
Starnes, Morelli, Naples and the Estate of Sallie C. Stroupe
filed petitions in the Tax Court contesting the Commissioner’s
notices of transferee liability. After a bench trial, the Tax
Court ruled in favor of the Former Shareholders.1 Applying
Stern, the Tax Court held that the Commissioner could only
collect from the Former Shareholders if, under North Carolina
law, a Tarcon creditor could recover payments of Tarcon’s
debts from the Former Shareholders. And applying North
Carolina law to the evidence presented at trial, the court held
that the Commissioner had not made the requisite showing.
On appeal, the Commissioner argues the Tax Court (1) com-
mitted legal error in its interpretation of federal law and its
application of state law and (2) clearly erred in making certain
factual findings.
Having carefully considered the parties’ arguments in light
of the record before us in this appeal, we conclude that the
Commissioner’s contentions lack merit. The Tax Court prop-
erly identified and applied the controlling legal framework as
set forth in Stern and it did not commit clear error in its fac-
tual findings. Therefore, we affirm the judgment in favor of
the Former Shareholders.
I.
A.
Starnes, Morelli, Naples and Stroupe began working at Tar-
con, a freight consolidation company, in the 1950s and 1960s.
Each rose through the ranks and, acting jointly, they pur-
chased Tarcon in 1972. They operated Tarcon for decades,
1
Although the Estate of Stroupe was the party in the Tax Court and is
the party on appeal, for consistency we refer to Stroupe or her Estate,
together with Starnes, Morelli and Naples, as the "Former Shareholders."
STARNES v. CIR 5
but business dropped off in the 1980s when the trucking
industry was deregulated. By 2003, Tarcon had ceased busi-
ness operations, and its sole remaining non-cash asset was a
large industrial warehouse in Charlotte, North Carolina,
which it leased to others, generating income.2 In 2003, the
Former Shareholders decided to retire and liquidate their
interests in Tarcon. Their goal was to maximize their after-tax
proceeds and minimize the expenses involved in any transac-
tions.
The Former Shareholders (who were also officers of Tar-
con) considered various options. One option was to sell the
warehouse, wind up the business, and distribute the resulting
cash assets to the shareholders. Another option was to main-
tain Tarcon as a going concern and sell their Tarcon stock.
Yet another option was a combined asset/stock sale, in which
Tarcon would sell the warehouse and then the Former Share-
holders would sell their stock in Tarcon (the sole asset of
which by then would be cash). They hired an independent
broker, Brad Cherry, a commercial real estate broker with
Keystone Partners, L.L.C., to act as an agent and adviser in
connection with leasing and/or selling the warehouse or sell-
ing Tarcon stock.
Cherry began marketing Tarcon’s assets and/or its stock in
light of the various options. Cherry received letters from sev-
eral parties expressing interest in purchasing the warehouse.
One of these letters was from ProLogis, a Maryland real
estate investment trust, which in April 2003 offered to pur-
chase the warehouse for $3,025,000.
By that time, the Former Shareholders had also received
(via Cherry) a letter of intent from MidCoast, which
2
Until 2003 Tarcon also owned four vehicles and a condominium in
Garden City, South Carolina. In 2003, the South Carolina property was
sold for $190,752 and the vehicles were sold to the Tarcon shareholders.
The proceeds of these sales were deposited in Tarcon’s bank account.
6 STARNES v. CIR
expressed interest in buying Tarcon’s stock from the Former
Shareholders. MidCoast’s letter, dated May 21, 2003, stated:
MidCoast is interested in purchasing the stock of
certain C-corporations that have sold business assets
and/or real estate. In instances where a C-corporation
has sold assets for a gain, MidCoast may have an
interest in purchasing 100% of the stock from the
shareholders for a price greater than the net value of
the corporation.
MidCoast pursues these acquisitions as an effective
way to grow our parent company’s core asset recov-
ery operations. It is important to note that after we
complete a stock acquisition, the target company is
not dissolved or consolidated, but is reengineered
into the asset recovery business and becomes an
income producer for us going forward.
J.A. 104. MidCoast also provided a brochure describing the
benefits to the Former Shareholders and Tarcon of undertak-
ing a joint asset/stock sale. The brochure stated its proposal
would "maximize [the Former Shareholders’] net after-tax
proceeds," "maximize( ) sale of all assets (i.e., written-off
receivables, etc.)," and "[r]educ[e] exposure to future claims,
losses, and litigation." J.A. 111. MidCoast’s materials also
represented that Tarcon would not be "dissolved, liquidated,
or merged into another Company." Id. Rather, MidCoast
would "put( ) Company into asset recovery business and oper-
ate( ) Company on a go-forward basis." Id. Furthermore, Mid-
Coast would "cause( ) the Company to satisfy its tax and other
liabilities." Id.
On June 30, 2003, two MidCoast representatives met with
Cherry and the Former Shareholders, together with their
accountant and attorney, in North Carolina. By that time,
ProLogis had submitted a revised letter of intent, and Mid-
Coast knew that Tarcon was negotiating with ProLogis for the
STARNES v. CIR 7
sale of the warehouse. Thus it was understood at the June 30
meeting that when MidCoast purchased the stock, Tarcon’s
only asset would be cash. At the meeting, the MidCoast repre-
sentatives reiterated that if the Former Shareholders were to
go forward with the proposed transaction, MidCoast would
replace the Former Shareholders as owners of the company,
Tarcon would continue to operate under MidCoast’s owner-
ship, and the 2003 Tarcon tax liabilities would be satisfied.
Every witness who knew the details of the stock sale, includ-
ing the attorney for MidCoast, testified that they had no rea-
son to believe MidCoast would not honor these commitments.
MidCoast also explained that it had undertaken a number of
transactions of this type.
As for the tax benefits, MidCoast supplied a chart that com-
pared the after-tax consequences to the Former Shareholders
of a liquidation of Tarcon versus a stock sale. With a liquida-
tion, the Former Shareholders would effectively be taxed
twice: once on the net taxable corporate gain generated from
selling the warehouse and again on the income generated
from the distribution of Tarcon’s cash to the Former Share-
holders. With a stock sale, they would only be taxed once, on
their capital gains; the corporate income taxes would be the
responsibility of Tarcon’s new owner, i.e., MidCoast.
The Former Shareholders testified they did not understand
what was meant by the "asset recovery business" or what
MidCoast planned to do with Tarcon, but they made no inqui-
ries. J.A. 707, 759-61, 823-24. Naples thought "it did sound
strange," but he believed that MidCoast bought "bad debts" to
"use . . . as a write-off against the companies they buy that
have money." J.A. 759. Starnes testified that "[i]t wasn’t
something I wanted to understand. Once they bought my
stock, they could do what they wanted with Tarcon." J.A. 824.
At one point, Tarcon’s accountant, Jerome Epping, who also
was the Former Shareholders’ accountant and who had
attended the meeting with MidCoast, made a notation on an
untitled and undated MidCoast worksheet questioning,
8 STARNES v. CIR
"‘2001-16’ reportable?," J.A. 603, referring to I.R.S. Notice
2001-16, which describes certain "intermediary transactions
tax shelters," transactions that in certain ways are similar to
the transactions at issue here.3 The Commissioner, however,
3
In Notice 2001-16, the IRS announced that it "may challenge the pur-
ported tax results" of certain transactions it considered that type of tax
shelter. I.R.S. Notice 2001-16, 2001-1 C.B. 730 (Feb. 26, 2001). The
transactions involved, among other things, the sale of a corporation’s stock
to one corporation (an "intermediary corporation") and sale of its assets to
a different person or entity. The primary purpose of the Commissioner’s
efforts is to ensure he collects taxes due on long-term gains on the assets.
In full, the pertinent part of the Notice explains:
These transactions generally involve four parties: seller (X)
who desires to sell stock of a corporation (T), an intermediary
corporation (M), and buyer (Y) who desires to purchase the
assets (and not the stock) of T. Pursuant to a plan, the parties
undertake the following steps. X purports to sell the stock of T
to M. T then purports to sell some or all of its assets to Y. Y
claims a basis in the T assets equal to Y’s purchase price. Under
one version of this transaction, T is included as a member of the
affiliated group that includes M, which files a consolidated
return, and the group reports losses (or credits) to offset the gain
(or tax) resulting from T’s sale of assets. In another form of the
transaction, M may be an entity that is not subject to tax, and M
liquidates T (in a transaction that is not covered by § 337(b)(2)
of the Internal Revenue Code or § 1.337(d)–4) of the Income Tax
Regulations, resulting in no reported gain on M’s sale of T’s
assets.
Depending on the facts of the particular case, the Service may
challenge the purported tax results of these transactions on sev-
eral grounds, including but not limited to one of the following:
(1) M is an agent for X, and consequently for tax purposes T has
sold assets while T is still owned by X, (2) M is an agent for Y,
and consequently for tax purposes Y has purchased the stock of
T from X, or (3) the transaction is otherwise properly recharacter-
ized (e.g., to treat X as having sold assets or to treat T as having
sold assets while T is still owned by X). Alternatively, the Ser-
vice may examine M’s consolidated group to determine whether
it may properly offset losses (or credits) against the gain (or tax)
from the sale of assets.
STARNES v. CIR 9
did not present evidence of what the MidCoast worksheet
entailed, why Epping made the notation, or whether he com-
municated with the Former Shareholders regarding potential
concerns about transferee liability.
B.
Having reviewed MidCoast’s proposal, the Former Share-
holders decided to accept it: Tarcon would sell the warehouse
to ProLogis, and the Former Shareholders would sell their
Tarcon stock to MidCoast. On July 30, 2003, ProLogis agreed
to buy the Granite Street property for $3.18 million. The sale
closed on October 30, 2003, and Tarcon received net proceeds
of $2,567,901.83.
Meanwhile, Morelli had been negotiating with MidCoast
for the purchase of the Tarcon stock. MidCoast proposed pur-
chasing the stock for an amount equal to Tarcon’s cash less
a percentage of Tarcon’s estimated federal and state tax liabil-
ity for 2003. The negotiations focused on that percentage,
referring to the excess of the purchase price over the net value
of Tarcon as the "asset recovery premium." J.A. 711-12, 150.
The parties retained prominent law firms to represent them in
the stock sale. MidCoast engaged the law firm of Womble,
Carlyle, Sandridge & Rice ("Womble Carlyle"), and the For-
mer Shareholders engaged Moore & Van Allen, as counsel.
On July 16, 2003, on behalf of Tarcon, Morelli executed a let-
ter of intent to sell the Tarcon stock to MidCoast. The parties
agreed MidCoast would buy all of Tarcon’s stock for an
Id. In 2008 the Commissioner issued another notice to "clarif[y]" Notice
2001-16. See I.R.S. Notice 2008-111, 2008-51 I.R.B. 1299 (Dec. 2, 2008).
Among other things, Notice 2008-111 explained that a transaction "is
treated as an Intermediary Transaction with respect to a particular person"
only if that person "knows or has reason to know the transaction is struc-
tured" in a way such that "the person or persons primarily liable for any
Federal income tax obligation with respect to the disposition of the Built-
in Gain Assets will not pay that tax." Id.
10 STARNES v. CIR
amount equal to Tarcon’s cash less 56.25 percent of Tarcon’s
local, state, and federal corporate income taxes for 2003. Mid-
Coast also agreed to reimburse the Former Shareholders and
Tarcon for legal and accounting fees, up to $25,000.
As of October 31, 2003, after the warehouse was sold, Tar-
con had approximately $3.1 million in cash and no other tan-
gible assets. The sale resulted in a corporate income tax
liability of approximately $880,000, in a pro forma calcula-
tion by Tarcon’s then accountant.4 Thus, as of October 31,
Tarcon’s total assets were $3.1 million and its total liabilities
were $880,000, resulting in a net worth of approximately $2.2
million.
As mentioned, the principal subject of negotiation had been
how much of Tarcon’s $880,000 tax liability MidCoast would
deduct from the value of Tarcon’s $3.1 million in cash to
determine the amount it was willing to pay for the Tarcon
stock. After the warehouse sale closed, the parties reached an
agreement: MidCoast would pay the Former Shareholders
approximately $2.6 million for their stock. This figure meant
the Former Shareholders would contribute 56.25 percent of
Tarcon’s presumed 2003 tax liability, and MidCoast would
cover the remainder. The stock sale closed on November 13,
2003. In the final Share Purchase Agreement, MidCoast reit-
erated a number of the commitments it had been making all
along, including that it would "file all Federal and state
income tax returns related to the [$881,627.74] Deferred Tax
Liability on a timely basis." J.A. 247.
After executing the Agreement, the Former Shareholders
resigned as officers of Tarcon and gave their original Tarcon
share certificates to their attorney at Moore & Van Allen. Tar-
con’s $3.1 million in cash was transferred to an escrow
4
Tarcon’s total gain on the warehouse, which it had bought in January
1978, was $2,366,915. This long-term gain resulted in an expected 2003
tax liability of $881,627.74.
STARNES v. CIR 11
account of Moore & Van Allen, and MidCoast’s $2.6 million
purchase money was transferred to its attorneys’ escrow
account.5 The Former Shareholders’ attorney at Moore & Van
Allen then hand delivered the Tarcon share certificates and
other original closing documents to Womble Carlyle’s office
and transferred Tarcon’s cash into Womble Carlyle’s escrow
account. From that account, which temporarily held both Tar-
con’s and MidCoast’s money, $649,034 was transferred to
each of the Former Shareholders (which they later reported as
income on their 2003 individual tax returns), and $25,000 was
transferred to Moore & Van Allen as reimbursement for its
services.
According to the Agreement, Tarcon’s $3.1 million was
supposed to be transferred into Tarcon’s "post-closing" bank
account. In fact, the cash took a detour. The closing attorney
at Womble Carlyle, rather than transferring the money to Tar-
con’s post-closing account, transferred the funds from the
Womble Carlyle trust account to the "MidCoast Credit Corp.
Operating Account." The record does not disclose how or
why this apparent mistake was made. In any event, the error
was remedied the next day, when the $3.1 million was wired
from the MidCoast operating account to a new Tarcon
account at SunTrust Bank.
C.
If all had gone as the Former Shareholders testified they
thought it would, MidCoast would have continued operating
Tarcon and in 2004 paid Tarcon’s 2003 taxes. That is not
what happened. Instead, on November 24, 2003, eleven days
after the November 13 closing, MidCoast sold its Tarcon
stock to Sequoia Capital, L.L.C., a Bermuda company, for
$2,861,465.96. Two days later, all of the funds in Tarcon’s
5
As the Tax Court aptly put it: "Thus, there was an infusion of cash into
the transaction, not a circular flow of cash." 101 T.C.M. (CCH) 1283,
2011 WL 894608, at *8.
12 STARNES v. CIR
SunTrust account were transferred to an account with Deut-
sche Bank AG, though still under Tarcon’s name. Then, on
December 1, 2003, $2,960,000 was transferred from the Deut-
sche Bank account to an account in the Cook Islands in the
name of "Delta Trading Partners," and $126,822 was trans-
ferred to a MidCoast bank account. After December 1, 2003,
Tarcon never had more than $132,320 in any account.
Tarcon filed its 2003 federal tax return in July 2004, report-
ing capital gains of $1,009,483 and ordinary income of
$1,557,315, principally from the sale of the warehouse and
the related grounds. Tarcon also reported, however, two large
losses. First, it reported a short-term capital loss of
$1,010,000 resulting from a purported December 2003 inter-
est rate swap option. Second, it reported an ordinary loss of
$1,950,000 resulting from a transaction involving an asset
denominated "DKK/USD BINA," which was purportedly
acquired on December 29, 2003, and purportedly sold on
December 31, 2003. Id. Consequently, the 2003 return stated
Tarcon’s only asset was $132,320 in cash. Thus, the return
reported an overall loss and no tax due. In 2005, Tarcon filed
its 2004 federal tax return, marked as its final return, reporting
no tax due and no assets.
D.
In 2005, in the midst of a "promoter penalty examination"
of MidCoast, the IRS audited Tarcon’s 2003 tax return. The
IRS disallowed the claimed deductions for the short-term cap-
ital loss of $1,010,000 and the ordinary loss of $1,950,000.
The IRS sent a notice of deficiency dated April 11, 2007, to
Tarcon, in which it explained:
You have failed to prove that the disposition of the
inflated basis assets generated a bona fide loss. In
addition, it is determined that the inflated basis
assets transaction lacked economic substance.
Accordingly, taxable income is increased
STARNES v. CIR 13
$2,959,483.00 for taxable year ending December 31,
2003.
J.A. 537. Having disallowed the claimed losses, the IRS
determined that Tarcon owed an income tax deficiency for
2003 of $855,237. The IRS also imposed an accuracy-related
penalty of $342,094.
Tarcon did not seek a redetermination of the asserted defi-
ciency in the Tax Court, and so an assessment of tax, penalty
and interest totaling $1,495,641 was made on September 17,
2007. Tarcon did not pay any portion of the deficiency, pen-
alty or interest for the underlying 2003 assessment. Nor was
the IRS able to satisfy the tax liability from tax liens it filed
in North Carolina and Nevada.
In December 2008, the IRS sent notices of transferee liabil-
ity to each of the Former Shareholders. The notices identified
the amount each Former Shareholder received when he or she
sold Tarcon shares to MidCoast, and stated that, as transfer-
ees, they were liable for Tarcon’s tax liability up to the
amount each received for those shares (not including applica-
ble interest). An attached notice of liability statement advised
that the IRS did not recognize the "purported stock sale" to
MidCoast. J.A. 20. "[T]he stock sale and the transactions
involving the sale of Tarcon, Inc.’s assets to ProLogis," the
notice continued, "are determined to be, in substance, a sale
of the assets of Tarcon, Inc., followed by a distribution by
Tarcon, Inc. of its proceeds to its shareholders." Id. The
attachment further explained that the transaction is "substan-
tially similar to an Intermediary transaction shelter described
in Notice 2001–16, 2001–1 C.B. 730," or, alternatively, the
transaction is in substance a sale of the Tarcon assets to
ProLogis followed by a redemption of Tarcon stock owned by
the Tarcon shareholders. Id.
The Former Shareholders filed petitions in the United
States Tax Court contesting the notices of transferee liability.
14 STARNES v. CIR
As discussed in detail below, the Tax Court ruled in favor of
the Former Shareholders, finding the IRS had failed to carry
its burden of proving the Former Shareholders were liable as
transferees for Tarcon’s 2003 taxes. Starnes v. Commissioner,
101 T.C.M. (CCH) 1283, 2011 WL 894608 (2011). The Com-
missioner timely appealed.
II.
We review decisions of the United States Tax Court "on the
same basis as decisions in civil bench trials in United States
district courts." Waterman v. Comm’r, 179 F.3d 123, 126 (4th
Cir. 1999). Questions of law are reviewed de novo, and find-
ings of fact for clear error. Id. The Commissioner challenges
both the Tax Court’s legal conclusions and its findings of fact.
We begin by explicating the legal framework applicable in
cases of this sort. We then explain why we discern no error
in the lower court’s application of the controlling legal princi-
ples. Finally, we examine the evidence and explain why we
are not persuaded by the Commissioner’s contention that the
lower court committed clear error in its factual findings.
A.
Until 1926, if the government was unable to collect taxes
from a particular taxpayer and believed the taxpayer’s assets
had been transferred to someone else, the government could
only proceed against the "transferee" of those assets by bring-
ing a bill in equity or an action at law. See Stern, 357 U.S. at
43. These procedures "proved unduly cumbersome, however,
in comparison with the summary administrative remedy
allowed against the taxpayer himself." Id. Thus, in 1926 Con-
gress authorized the Commissioner to collect taxes from
transferees of a taxpayer’s assets "by the procedure provided
in the [Internal Revenue Code] for the enforcement of tax
deficiencies." Id. (quoting S. Rep. No. 52, 69th Cong., 1st
Sess. 30). It enacted the predecessor of 26 U.S.C. § 6901(a),
STARNES v. CIR 15
which today in pertinent part (only non-substantive revisions
having been made since 1926) reads as follows:
Method of collection.—The amounts of the follow-
ing liabilities shall, except as hereinafter in this sec-
tion provided, be assessed, paid, and collected in the
same manner and subject to the same provisions and
limitations as in the case of the taxes with respect to
which the liabilities were incurred:
(1) Income, estate, and gift taxes.—
(A) Transferees.—The liability, at law or
in equity, of a transferee of property—
(i) of a taxpayer in the case of a tax
imposed by subtitle A (relating to
income taxes) . . .
26 U.S.C. § 6901(a) (emphasis added). A "transferee"
includes a "donee, heir, legatee, devisee, [or] distributee." Id.
§ 6901(h). Treasury regulations further provide that "the term
‘transferee’ includes . . . the shareholder of a dissolved corpo-
ration, . . . the successor of a corporation, . . . and all other
classes of distributees." 26 C.F.R. § 301.6901-1(b).
In Stern, the government sought to collect from a widow
whose husband had died deficient in his payment of income
taxes. 357 U.S. at 40. The husband had held a life insurance
policy from which he could draw down cash during his life,
and which named his wife as the beneficiary. Id. at 41. The
question was whether the widow’s "substantive liability" for
her deceased husband’s tax deficiency was to be determined
"by state or federal law." Id. at 42. After closely examining
§ 6901’s legislative history, the Court concluded Congress
intended § 6901 to be "purely a procedural statute." Id. at 44.
To determine a transferee’s "substantive liability," the Court
concluded it must look to sources other than § 6901. No other
16 STARNES v. CIR
federal statute having defined transferees’ substantive liabil-
ity, the Court was required to choose between "federal deci-
sional law and state law." Id. Citing Erie Railroad Company
v. Tompkins, 304 U.S. 64 (1938), the Court concluded,
"[U]ntil Congress speaks to the contrary, the existence and
extent of liability should be determined by state law," specifi-
cally the law of the state where a particular transfer was made.
357 U.S. at 45.
The Commissioner had argued federal common law should
apply to a transferee’s substantive liability, in part because
"the varying definitions of liability under state statutes
resulted in an absence of uniformity of liability." Id. The
Court did not find this argument based on absence of unifor-
mity persuasive. Congress knew courts had been applying
state law "developed for the protection of private creditors" to
determine transferees’ liability for a transferor’s federal taxes.
Id. at 44-45. Yet Congress, "with knowledge that this was
‘existing law’[,] . . . refrained from disturbing the prevailing
practice." Id. The Court explained:
Uniformity is not always the federal policy. Under
§ 70 of the Bankruptcy Act, for instance, state law is
applied to determine what property of the bankrupt
has been transferred in fraud of creditors. What is a
good transfer in one jurisdiction might not be so in
another. . . . Since Congress has not manifested a
desire for uniformity of liability, we think that the
creation of a federal decisional law would be inap-
propriate in these cases.
Id. at 45 (citations omitted). "Congress has not seen fit to
define that liability," and so "none exists except such as it is
imposed by state law." Id. at 47. In Stern, "Kentucky law
impose[d] no liability against [Stern] in favor of [her hus-
band’s] other creditors," and therefore she was not liable for
her deceased husband’s unpaid taxes. Id.
STARNES v. CIR 17
Thus, Stern stands for the proposition that § 6901 "neither
creates nor defines a substantive liability but provides merely
a new procedure by which the Government may collect
taxes." Id. at 42. As the Tax Court in this case properly articu-
lated, § 6901 "provides a procedure through which the IRS
may collect unpaid taxes owed by the transferor of the assets
from a transferee if an independent basis exists under applica-
ble State law or State equity principles for holding the trans-
feree liable for the transferor’s debts." Starnes, 2011 WL
894608, at *6. "[T]he Government’s substantive rights against
the transferee are precisely those which other defrauded credi-
tors would have under the law of the state in which the trans-
fers were made." John Ownbey Co. v. Commissioner, 645
F.2d 540, 543 (6th Cir. 1981) (internal parentheses and quota-
tion marks omitted).
Notably for our purposes, Stern also teaches another lesson:
whether there has been a "transfer" within the meaning of
§ 6901 (and concomitantly whether a person is a "transferee"
within the meaning of the statute)—a question undisputedly
of federal law—is a separate question from whether the
alleged transferee is substantively liable for a transferor’s
unpaid taxes. In Stern, the Court assumed without deciding
that Stern was "a transferee within the meaning of [§ 6901]."
Stern, 357 U.S. at 41-42. Having avoided deciding that proce-
dural question, it held the Commissioner could not prevail
because "Kentucky statutes govern the question of the benefi-
ciary’s liability," and under Kentucky law Stern was not liable
to her deceased husband’s creditors. Id. at 42.
Thus, to collect taxes from an alleged transferee, the Com-
missioner must prevail on each of these independent require-
ments, one procedural and governed by federal law, the other
substantive and governed by state law. The burden of proof
on each is on the Commissioner. 26 U.S.C. § 6902(a) ("In
proceedings before the Tax Court the burden of proof shall be
18 STARNES v. CIR
upon the Secretary to show that a petitioner is liable as a
transferee of property of a taxpayer . . .").6
B.
In the instant case, the Commissioner seeks to collect from
the Former Shareholders the taxes Tarcon owed for 2003 and
did not pay. As for the availability of the § 6901 collection
procedure, he asserts the economic "reality" is that the
November 13-14, 2003, transactions resulted in the transfer of
Tarcon’s cash to the Former Shareholders, and thus they are
distributees of Tarcon’s assets. On the substantive prong of
the analysis, the Commissioner argues four provisions of
North Carolina law would each render the Former Sharehold-
ers liable to Tarcon’s creditors for debts incurred by Tarcon
prior to the sale of Tarcon stock to MidCoast (and thereby
render them actually liable for Tarcon’s unpaid 2003 taxes):
three provisions of the North Carolina Uniform Fraudulent
Transfer Act ("NCUFTA"), and the common-law doctrine of
corporate trust fund liability.
In the proceedings below, the Tax Court, following the
Supreme Court’s lead in Stern, assumed the Commissioner
had proven the Former Shareholders were transferees within
the meaning of § 6901, and therefore could invoke the admin-
istrative procedure provided by that section. After resolving
that issue in the Commissioner’s favor, the Tax Court pro-
ceeded to determine whether the Commissioner had satisfied
his burden to prove the Former Shareholders’ substantive lia-
bility, i.e., whether "an independent basis exists under appli-
cable State law or State equity principles for holding the
6
While the Commissioner does not have the burden to show "that the
taxpayer [Tarcon] was liable for the tax," 26 U.S.C. § 6902(a), that is irrel-
evant here because whether Tarcon was liable for the approximately
$881,000 in corporate income taxes in 2003 is not disputed. The disputed
issues are whether the Shareholders are transferees under § 6901 and
whether they are liable to Tarcon’s creditors under North Carolina law.
STARNES v. CIR 19
transferee liable for the transferor’s debts." Starnes, 101
T.C.M. (CCH) 1283, 2011 WL 894608, at *6. The Tax Court,
after a bench trial and making factual findings, rejected each
of the proffered bases for substantive liability in a 33-page
memorandum opinion.
As mentioned, on appeal the Commissioner argues the Tax
Court applied incorrect legal principles and committed clear
error in making several of its factual findings. We address
each of the Commissioner’s arguments in turn.
C.
The Commissioner first argues, and our good colleague
agrees in his dissenting opinion, the Tax Court committed
legal error by treating the question of the Former Sharehold-
ers’ substantive liability under state law as independent of
whether, under § 6901, they are "transferees." The Commis-
sioner reads § 6901 as requiring a two-step analysis with the
second step wholly dependent on the first step. First, the
Commissioner and the dissent argue, courts should determine
whether a person or entity is a "transferee" under federal law,
that is, whether a particular set of transactions should be re-
cast under the "substance-over-form" doctrine derived from
federal tax cases. Second, the Commissioner and the dissent
argue, courts should apply state law to the transactions as
recast under federal law. In other words, they argue, the
"facts" to which we apply state law, such as state fraudulent
conveyance statutes, depend in part on whether someone is a
"transferee" for § 6901 purposes; therefore, the first step is a
"threshold question," one courts must resolve before deciding
whether a person or entity is substantively liable under state
law. See, e.g., Appellant’s Br. at 34 ("The Tax Court, how-
ever, never directly addressed whether the Shareholders were
transferees. This was legal error.").
Stern forecloses that argument. In Stern, as noted, the Court
addressed whether a person’s "substantive liability" was
20 STARNES v. CIR
determined by state or federal law. 357 U.S. at 42. On that
question, it concluded state law applied. In reaching that con-
clusion, it assumed without deciding that Stern was "a trans-
feree within the meaning of [§ 6901]." Id. at 41-42. If Stern’s
liability under state law had somehow depended on whether
she was a transferee under federal law, the Court could not
have found it "unnecessary to decide whether [she] was a
transferee within the meaning of [§ 6901]." Id. The Court did
find it unnecessary to decide that question, however, and thus
it did not undertake to make a threshold determination of
whether there was a "transfer" that informed the application
of state law to the facts. Moreover, the Court explicitly con-
sidered § 6901 "purely a procedural statute," and the "exis-
tence and extent" of an alleged transferee’s substantive
liability to be determined purely as a matter of state law.
Stern, 357 U.S. at 44-45.
Furthermore, while the dissent argues Stern is distinguish-
able, the supposedly distinguishing factors it relies upon are
immaterial. In Stern, the state-law basis for the alleged trans-
feree’s substantive liability required evidence that the dece-
dent paid his life insurance premiums "with intent to defraud
his creditors"; if he had, then the disbursement of the policy
to his widow would be considered fraudulent with respect to
his creditors, at least to the extent of the "premiums paid in
fraud of [those] creditors." 357 U.S. at 46 n.4 (citing Ky. Rev.
Stat. Ann. § 297.140 (1948)). Here, unlike in Stern, one ele-
ment of each of the state-law bases for liability is that there
was a "transfer." Also unlike in Stern, there are multiple trans-
fers we must decide whether to "collapse" to determine
whether they were fraudulent (i.e., we must determine "which
transaction is under review," Dissenting Op. at 43). In light of
these distinctions, the dissent argues, Stern does not apply
here, and, unconstrained by Stern, we should apply federal
law rather than state law to decide which if any transfers to
collapse.
Stern, however, did not turn on whether there is overlap
between the factual determinations required by the federal-
STARNES v. CIR 21
law and state-law prongs of the analysis. Rather, the Court
treated those two questions as entirely independent; whether
there was a "transfer" of assets from the decedent to Stern (for
§ 6901 purposes) was irrelevant to whether that transfer was
fraudulent (for state law purposes). We are unpersuaded that
Stern’s instruction that state law governs substantive liability
is inapplicable where one element of the relevant state law is
that there was a "transfer." Similarly, as we explain in greater
detail below, we believe the question of which if any of the
multiple transactions should be "collapsed" to determine
whether they were fraudulent is a question of substantive lia-
bility, not merely a question of the availability of the § 6901
procedure, and thus is governed by state law.
In short, we conclude Stern forecloses the Commissioner’s
efforts to recast transactions under federal law before apply-
ing state law to a particular set of transactions. An alleged
transferee’s substantive liability for another taxpayer’s unpaid
taxes is purely a question of state law, without an antecedent
federal-law recasting of the disputed transactions. In terms of
"the existence and extent of liability," Stern places the IRS in
precisely the same position as that of ordinary creditors under
state law. 357 U.S. at 45; see also Sellers v. Comm’r, 592
F.2d 227, 229 (4th Cir. 1979) (affirming Tax Court judgment
against transferee because (1) the taxpayer’s profits "found
their way into petitioner’s possession" and (2) the transfer was
void under Virginia law because Sellers received the proceeds
without paying consideration and intended to hinder and delay
creditors); C.D. Constr. Corp. v. Comm’r, 451 F.2d 470, 471-
72 (4th Cir. 1971) (affirming Tax Court judgment against
alleged transferee because (1) "in substance" it had received
a corporate distribution from the taxpayer and (2) no consid-
eration was given, and so the distribution was void under
West Virginia law).
In this case, because the two questions are independent, and
because the Commissioner has failed to prove the Former
Shareholders are liable under state law (as explained within),
22 STARNES v. CIR
we need not and do not decide whether they are the "transfer-
ees" of Tarcon’s cash within the meaning of § 6901. The
Commissioner’s position that the "substance-over-form" doc-
trine developed in federal tax cases governs the latter ques-
tion, that the doctrine disregards the parties’ actual or
constructive knowledge (or lack thereof), and that in sub-
stance the Former Shareholders received a distribution of Tar-
con’s cash (with MidCoast receiving a "fee"), may well be a
correct framing of the issues related to the § 6901 "transferee"
question.7 But because the Commissioner’s efforts fail on the
state-law front, we proceed directly to explain why the Tax
Court did not commit legal error or clear factual error in con-
cluding the Former Shareholders are not liable under North
Carolina law.
D.
We turn now to the state-law bases for the Former Share-
holders’ alleged substantive liability. The first three arise
under North Carolina’s version of the Uniform Fraudulent
Transfer Act, the NCUFTA. The fourth arises under North
Carolina common law.
1.
We begin with the first of the three NCUFTA provisions
7
Or it may be incorrect. In one of the other transferee liability cases
recently decided by the Tax Court, the court rejected the Commissioner’s
efforts to recast certain transactions using the substance-over-form doc-
trine precisely because the original shareholders of the corporation being
sold "had no reason to believe that [the stock purchaser’s] methods were
illegal or inappropriate" and thus "did not have a duty to inquire further
and are not responsible for any tax strategies [an affiliate of the stock pur-
chaser] used after the closing of the stock sale." Slone v. Comm’r, 103
T.C.M. (CCH) 1265, 2012 WL 691401, *10 (2012). We need not and do
not decide the extent to which, if any, a person or entity’s constructive
knowledge is relevant to the application of the federal substance-over-
form doctrine in this context.
STARNES v. CIR 23
relied on by the Commissioner: N.C. Gen. Stat. § 39-23.5.
That subsection provides in pertinent part that a "transfer"
made by a debtor "is fraudulent as to a creditor whose claim
arose before the transfer was made," if the debtor (1) made
the transfer "without receiving a reasonably equivalent value
in exchange," and (2) "was insolvent at that time" or "became
insolvent as a result of the transfer." Id.
This is where the Commissioner and dissent argue the
"transferee" determination under federal law informs the
determination of liability under state law. The argument is as
follows: Under the substance-over-form doctrine developed in
federal tax cases, the Former Shareholders received a "trans-
fer" of Tarcon’s cash. The fact that a "transfer" occurred for
§ 6901 purposes means a "transfer" occurred for NCUFTA
purposes. As the "creditor[s]" in that "transfer," the Former
Shareholders were required to give Tarcon "a reasonably
equivalent value in exchange," lest Tarcon become "insolvent
as a result of the transfer." N.C. Gen. Stat. § 39-23.5. The For-
mer Shareholders did not give Tarcon "reasonably equivalent
value" in exchange for its cash, says the Commissioner,
because as of December 1, 2003, Tarcon was left with just
$132,000; therefore, the Commissioner argues, the "transfer"
was "fraudulent" as to the Former Shareholders, and the For-
mer Shareholders are liable for the tax liability Tarcon
incurred prior to the transfer.
This argument has some facial appeal. After all, should not
a "transfer" under federal law be a "transfer" under state law?
The answer, however, is "not necessarily"—because Stern
tells us so. In Stern, as explained above, the Court assumed
without deciding that the taxpayer’s widow was a "trans-
feree." After deciding that state law governed her substantive
liability for her deceased husband’s unpaid taxes, the Court
turned to Kentucky law. Under Kentucky law, a defrauded
creditor could only recover from a transferee in the widow’s
position if the insured had paid life insurance premiums "in
fraud of creditors." 357 U.S. at 46. There was no evidence of
24 STARNES v. CIR
fraud, whether actual or constructive. Therefore, the Court
held, the widow was not liable for her deceased husband’s
taxes, even assuming she was a "transferee" for § 6901 pur-
poses.
Here, the Commissioner argues the Former Shareholders
are substantively liable for Tarcon’s unpaid taxes because
there was a "transfer" of Tarcon’s (all cash) assets to the For-
mer Shareholders, and the transfer was fraudulent under
North Carolina law. In Stern, the Supreme Court treated the
alleged transferee’s substantive liability as purely a question
of state law. We must do the same here. As we suggest above,
it may well be that the series of transfers on November 13-14
and December 1, 2003, in the aggregate, constitute a "trans-
fer" for § 6901 purposes. But we need not and do not decide
that question because, as explained infra, they do not consti-
tute a single "transfer" for NCUFTA purposes.8
8
The Commissioner places heavy reliance on Lowndes v. United States,
384 F.2d 635 (4th Cir. 1967), and Owens v. Commissioner, 568 F.2d 1233
(6th Cir. 1977), in support of his argument that federal law rather than
state law governs whether to collapse the November 13-14 and December
1, 2003, transactions. Lowndes is unavailing, however, because it did not
involve transferee liability pursuant to § 6901. In that case, a taxpayer had
purchased all of the outstanding stock of four corporations, which were
liquidated six months later. 384 F.2d at 636. The question was whether the
taxpayer (1) received ordinary income at the time of the purchase, or (2)
received income, taxable either as long term capital gain or as ordinary
income, at the time of liquidation. Id. There was no question of transferee
liability, and so Stern did not apply and the issue was one purely of federal
law.
The reason Owens is distinguishable is a bit more complicated, but it
is materially distinguishable nonetheless. Owens was the sole shareholder
of an S corporation, Mid-Western, that had been involved in various ven-
tures but by mid-1965 held only $299,822.62 in cash. 568 F.2d at 1236.
In August 1965 he entered a contract purporting to sell Mid-Western’s
stock to two buyers for $262,842.26. Id. He reported his income from the
sale as long-term capital gain. Id. Meanwhile, post-closing, the buyers,
who apparently had planned to offset Mid-Western’s 1964 gains with
another corporation’s losses, liquidated and dissolved Mid-Western. Id.
STARNES v. CIR 25
The question is thus: under North Carolina law, what trans-
fer or combination of transfers should be considered to deter-
mine whether Tarcon received reasonably equivalent value
and/or was rendered insolvent? Under the facts here, there are
two options, depending on the time frame. The first option,
the one advocated by the Former Shareholders and adopted by
The Commissioner issued two notices of deficiency against Owens.
First, he asserted the 1965 transaction was in substance a distribution of
Mid-Western’s cash to Owens, not a bona fide sale of stock, and so Owens
owed taxes on the company’s 1965 S-corporation income—not capital
gains taxes on the amount he received in the purported sale. Id. Second,
the Commissioner asserted that (a) certain deductions Mid-Western had
claimed for 1964 related to cattle feed were not allowable, (b) Owens was
the transferee of Mid-Western’s assets, and (c) as transferee Owens was
liable for the 1964 deficiency. The Tax Court agreed with the Commis-
sioner’s theory on both notices. Owens v. Comm’r, 64 T.C. 1, 11-16
(1975).
The Sixth Circuit affirmed the Tax Court’s decision on the first notice,
agreeing that in substance Owens received a distribution of Mid-Western’s
assets, and that the distribution was taxable as ordinary S-corporation
income, not the proceeds of a stock sale. Owens, 568 F.2d at 1240. As to
the asserted 1964 deficiency—the deficiency involving asserted transferee
liability—the court reversed, concluding the deduction was allowable.
Because there was no deficiency, the court did not reach the question
whether Owens was a "transferee" within the meaning of § 6901. See id.
at 1246.
The Commissioner argues the facts here are analogous to those in
Owens, and because in Owens the court re-characterized the purported
stock sale as a distribution of the corporation’s assets to the shareholder,
we should do the same here. The portion of Owens the Commissioner
relies upon, however, relates to the first notice of deficiency at issue in
Owens—which did not involve § 6901 transferee liability. Rather, the
issue was whether to treat the S corporation’s 1965 income as having been
distributed to the sole shareholder or retained by the corporation, an issue
purely of federal law, at least in the circumstances there. While § 6901
transferee liability might have become relevant if the court had found the
claimed 1964 deduction disallowable, the court did not so find; accord-
ingly, the court had no occasion to consider the Supreme Court’s instruc-
tion in Stern that state law governs an alleged transferee’s substantive
liability.
26 STARNES v. CIR
the Tax Court, is to consider only the transfers that occurred
on November 13 and 14, 2003. During those two days, $3.1
million in cash was transferred from Tarcon to MidCoast’s
attorneys’ escrow account and then back into a post-closing
Tarcon account, and a separate and distinct $2.6 million in
cash was transferred from MidCoast to the Former Sharehold-
ers, via the same escrow account. At the end of that period,
Tarcon had $3.1 million in its account, the same amount it
had prior to closing. The second option, the one advocated by
the Commissioner, is to consider not only the November 13-
14 transfers, but also the December 1 transfer of Tarcon’s
cash to the "Delta Trading Partners" account in the Cook
Islands, after which Tarcon was left with just slightly more
than $130,000 in its accounts.9
Which time frame applies is dispositive as to whether the
transfers were fraudulent with respect to the Former Share-
holders. On one hand, if the first, narrower combination of
transfers is considered the "transfer" for NCUFTA purposes,
Tarcon unquestionably received "reasonably equivalent
9
The Commissioner also offers a third alternative time frame, one even
shorter than the Former Shareholders’ timeframe: He argues that the rele-
vant "transaction" included only the transfers that occurred on November
13. At that time, Tarcon had no assets in its accounts, because instead of
immediately transferring the cash in Womble Carlyle’s escrow account to
a Tarcon account, the closing attorney at Womble Carlyle transferred the
cash first to a MidCoast account, and only the next day to a Tarcon
account. This seems clearly to have been a mistake, however, despite the
Commissioner’s argument below that the mistake is evidence MidCoast
intended to bleed Tarcon dry. Within 24 hours the error was corrected
when MidCoast transferred the cash into Tarcon’s account. The dissent
argues in effect that because the Share Purchase Agreement did not "re-
quire" that Tarcon’s cash be returned to Tarcon after the closing, Dissent-
ing Op. at 48, the Tax Court committed clear error by finding that the one-
day delay did not result in the funds being "unavailable" to Tarcon to sat-
isfy its liabilities. Starnes, 101 T.C.M. (CCH) 1283, 2011 WL 894608, at
*8. We disagree. There was substantial evidence that the Former Share-
holders expected the funds to be transferred back to Tarcon, as of course
they were within a day of the closing. We conclude the district court did
not clearly err in this regard.
STARNES v. CIR 27
value" and was not rendered "insolvent as a result of the
transfer." On the other hand, if the combination of transfers
in this broader time frame constitutes the "transfer" for
NCUFTA purposes, Tarcon unquestionably did not receive
reasonably equivalent value in the exchange. This is because
the December 1 transfer, in one fell swoop, took Tarcon from
being fully able to meet its tax obligations to being entirely
unable to do so.
The Tax Court held the shorter time frame controls because
under North Carolina law the transactions are only "col-
lapsed" if the Former Shareholders had actual or constructive
"knowledge of the entire scheme," and the Commissioner did
not prove, even by a preponderance standard (rather than the
clear and convincing evidence standard urged by the Former
Shareholders), that the Former Shareholders had actual or
constructive knowledge of the later transactions. On appeal,
the Commissioner argues the Tax Court erred in choosing the
shorter timeframe, for two reasons: first, the court applied the
wrong legal standard for whether to "collapse" the transac-
tions, and second, the Tax Court’s finding that the Former
Shareholders lacked the requisite knowledge of the nature of
the "entire scheme" to "collapse" the transactions was clearly
erroneous. We reject the Commissioner’s contentions for the
reasons explained within.
i.
As to the legal standard, the Commissioner first argues the
Tax Court required him to prove the Former Shareholders had
"knowledge of the entire scheme," by which it allegedly
meant evidence they knew "the precise manner in which Mid-
Coast would cause Tarcon to evade its taxes." Appellant’s Br.
at 57 (emphasis added). This was legal error, the Commis-
sioner argues, because North Carolina law does not require
the Commissioner to prove that the Former Shareholders
knew precisely how MidCoast would cause Tarcon to fail to
pay its 2003 taxes.
28 STARNES v. CIR
As a literal matter, the Commissioner is correct as to the
standard: the question was not whether the Former Sharehold-
ers knew precisely how Tarcon would become delinquent on
its taxes under MidCoast’s ownership, but rather whether they
knew (or should have known) that Tarcon would become
delinquent in fact. But the Commissioner over-reads the Tax
Court’s opinion. While the court did describe the standard as
requiring knowledge of "the entire scheme," 101 T.C.M.
(CCH) 1283, 2011 WL 894608, at *10, in context it is appar-
ent the court did not require the Commissioner to prove the
Former Shareholders knew that MidCoast would, for exam-
ple, claim a deduction for a purported interest rate swap
option to offset the gain realized from the sale of the ware-
house. Rather, the court required the Commissioner to prove
simply that the Former Shareholders knew or should have
known before the deal closed that MidCoast would cause Tar-
con to fail to pay its 2003 taxes. This was the proper inquiry.10
10
Our conclusion that the Tax Court applied the correct standard is but-
tressed by the primary case it cited for the "entire scheme" standard: HBE
Leasing Corp. v. Frank, 48 F.3d 623 (2d Cir. 1995). In that case, the Sec-
ond Circuit held that because a mortgagee knew or should have known
that the mortgage "was part of a single transaction from which [the mort-
gagor] received no benefit," the mortgagee was liable to the mortgagor’s
creditors under New York’s version of the Uniform Fraudulent Convey-
ance Act, the predecessor to the Uniform Fraudulent Transfer Act. Id. at
629. Although elsewhere the HBE Leasing court described the standard as
requiring "actual or constructive knowledge of the entire scheme that ren-
ders [the mortgagee’s] exchange with the debtor fraudulent," id. at 635
(emphasis added), it did not require knowledge of the precise details of a
particular scheme, but rather knowledge simply that no fair consideration
was received in exchange for the mortgage. See id. at 629; see also United
States v. Tabor Court Realty Corp., 803 F.2d 1288, 1296-97, 1303 (3d Cir.
1986) (collapsing, under Pennsylvania’s analog to N. C. Gen. Stat. § 39-
23.5(a), a series of transactions comprising a leveraged buy-out because
the lender/mortgagee "knew or strongly suspected that the imposition of
the loan obligations secured by the mortgages and guarantee mortgages
would probably render [the debtor] insolvent" and "was fully aware that
no individual member of the [debtor] would receive fair consideration
within the meaning of the Act in exchange for the loan obligations").
STARNES v. CIR 29
The Commissioner next argues that, even if we conclude
the Tax Court applied the narrower standard, the court erred
in articulating the standard for whether the Former Sharehold-
ers should have known (i.e., had constructive knowledge) that
MidCoast would cause Tarcon to fail to pay the taxes. We dis-
agree on that score as well.
Under North Carolina law, the question of constructive
knowledge has two components. As applied to the circum-
stances here, they are: First, did the Former Shareholders have
actual knowledge of facts that would have led a reasonable
person concerned about Tarcon’s solvency to inquire further
into MidCoast’s post-closing plans? Second, if the Former
Shareholders were thereby on "inquiry notice," whether the
inquiry a reasonably diligent, similarly-situated person would
have undertaken revealed MidCoast’s plan to leave Tarcon
unable to pay its 2003 taxes? See, e.g., Vail v. Vail, 63 S.E.2d
202, 207-08 (N.C. 1951) ("[One] having notice must exercise
ordinary care to ascertain the facts, and if he fails to investi-
gate when put upon inquiry, he is chargeable with all the
knowledge he would have acquired, had he made the neces-
sary effort to learn the truth . . . .") (brackets added; quota-
tions and citations omitted); Nash v. Motorola Commc’ns &
Elecs., Inc., 385 S.E.2d 537, 538 (N.C. Ct. App. 1989)
("Plaintiff will be deemed to have had inquiry notice if . . . he
could have ascertained by a reasonably diligent effort from
facts available to him that he was in violation."). Thus, if the
Former Shareholders were on inquiry notice of MidCoast’s
plans and failed to make reasonably diligent inquiry, they are
charged with the knowledge they would have acquired had
they undertaken the reasonably diligent inquiry required by
the known circumstances.
We are confident this is the standard the Tax Court applied.
The court found the Commissioner satisfied his burden on
prong one because it found that although the circumstances
did oblige the Former Shareholders to conduct "[f]urther
inquiry," they "failed to do so." See 101 T.C.M. (CCH) 1283,
30 STARNES v. CIR
2011 WL 894608, at *10. Nevertheless, the court ultimately
found (as described below) the Former Shareholders were not
chargeable with constructive knowledge of the MidCoast
scheme. The opinion thus makes apparent the court’s implied
premise: that the Commissioner was required to prove that no
reasonably diligent person in the Former Shareholders’ posi-
tion would have failed to discover that MidCoast would cause
Tarcon not to pay its 2003 taxes. This was the correct stan-
dard under North Carolina law.
ii.
By imposing that standard and yet finding the Commis-
sioner failed to satisfy his burden of proof on constructive
knowledge, the Tax Court reasonably (if only implicitly)
found that no reasonably diligent inquiry by the Former
Shareholders would have disclosed MidCoast’s intent to
cause Tarcon to fail to pay its taxes. Put differently, even
though the Former Shareholders might have conducted further
inquiry, such a hypothetical effort would not likely have
revealed MidCoast’s post-closing plans to evade Tarcon’s tax
liability.
On appeal, the Commissioner argues these factual findings
are clearly erroneous. He argues the Former Shareholders
"knew or should have known that MidCoast had tax-
avoidance intentions, even if they were not privy to the pre-
cise schemes that MidCoast would later employ to evade the
taxes." Appellant’s Br. at 57. While the Former Shareholders
"claimed that they believed MidCoast’s assertion that it was
acquiring Tarcon to integrate the corporation into MidCoast’s
‘asset recovery business,’" the Commissioner argues, this
belief "is doubtful" and, in any event, is "completely unrea-
sonable." Id. at 58. The dissent shares the Commissioner’s
view that the lower court clearly erred in finding that the For-
mer Shareholders lacked the requisite constructive knowl-
edge.
STARNES v. CIR 31
The Commissioner vigorously argues the Former Share-
holders should have known what 20/20 hindsight now seems
to confirm, namely, that MidCoast had no purpose in acquir-
ing Tarcon’s stock "other than to facilitate a tax shelter." Id.
The Commissioner identifies a number of reasons for this
contention supported by the evidence: MidCoast’s promo-
tional materials stated it targeted corporations that held only
cash and offered shareholders a way to minimize their tax
burden; MidCoast’s offer to buy Tarcon’s stock was contin-
gent on Tarcon holding only cash; the negotiations revolved
largely around the percentage of the amount of Tarcon’s 2003
taxes that MidCoast would pay the Former Shareholders as a
"premium," which ended up as approximately $400,000; and
Tarcon was a defunct shell with no means to generate addi-
tional income.
Moreover, the Commissioner emphasizes, the Former
Shareholders’ inquiry was not reasonably diligent: they did
not investigate MidCoast’s asset recovery business; they did
not obtain a tax opinion regarding the stock sale; Naples
acknowledged that paying cash for a corporation that held
only cash "did sound strange," J.A. 759; another Former
Shareholder (Starnes) testified that although he did not under-
stand MidCoast’s promotional materials, "[i]t wasn’t some-
thing I wanted to understand," and "[o]nce they bought my
stock, they could do what they wanted to with Tarcon," J.A.
824; Starnes also testified that once Tarcon’s cash left the cor-
porate bank account, "we didn’t follow it any more, because
we didn’t own the company any more," J.A. 823; Stroupe
asked at the closing whether the MidCoast deal was "com-
pletely legal," J.A. 801; and the Former Shareholders’
accountant questioned whether the sale was "‘2001-16’
reportable," J.A. 601-03, but failed to confirm whether it was
or was not covered by I.R.S. Notice 2001-16. Finally, the
Commissioner argues, "[r]easonable inquiry would have, at
least, disclosed the existence of Notice 2001-16," which
would have "explicitly cautioned the Shareholders that their
transaction with MidCoast was substantially similar to other
32 STARNES v. CIR
intermediary transactions considered to be tax shelters."
Appellant’s Br. at 61.
This evidence certainly supports the Commissioner’s posi-
tion in this litigation. But they do not persuade us that the Tax
Court was clearly erroneous in finding that, under the circum-
stances shown by the evidence, the Former Shareholders
lacked constructive knowledge that Tarcon was unlikely to
pay its 2003 taxes. To the contrary, there was ample counter-
vailing evidence to that relied on by the Commissioner sup-
porting the lower court’s finding that the admittedly limited
inquiry by the Former Shareholders did little to bolster the
Commissioner’s case. Properly viewed, as we suggest above,
the Tax Court clearly found that the Former Shareholders
would not have learned through further inquiry so much more
of MidCoast’s intentions to justify the court’s imposition of
constructive knowledge.
MidCoast represented that Tarcon would not be "dissolved
or consolidated" but rather "reengineered into the asset recov-
ery business" and become an "income producer" for MidCoast
"going forward." J.A. 104. It also repeatedly represented that
it would ensure that Tarcon would pay its 2003 taxes. Mid-
Coast’s professional-looking brochure stated that MidCoast
was a well-established business that was incorporated in 1958
and in 1996 transitioned from mortgage banking to asset
recovery, mostly collecting defaulted credit card debts. At
every turn, MidCoast represented that Tarcon would continue
to operate as a business, and that Tarcon would pay its 2003
taxes.
There is still further evidence the Former Shareholders’
efforts to ascertain MidCoast’s post-closing plans were rea-
sonable as measured against the hypothetical, "reasonably dil-
igent" efforts North Carolina law contemplates. Joseph
Cogdell, MidCoast’s attorney who also served as the closing
attorney for the stock sale, testified that he had no reason to
believe MidCoast would fail to abide by its contractual obli-
STARNES v. CIR 33
gation to ensure Tarcon’s 2003 taxes would be paid. At the
time of the transaction, he was a senior member of the corpo-
rate and securities practice group at Womble Carlyle, held an
L.L.M. in taxation, and was intimately familiar with the
details of the transaction. Similarly, Brad Cherry, Tarcon’s
real estate broker, testified that MidCoast’s representatives
struck him as ordinary businessmen, and nothing in Mid-
Coast’s proposals raised any concern with him.11 He also
checked MidCoast’s references and apparently received very
positive feedback, and reported to the Former Shareholders
that MidCoast was a "reputable firm." J.A. 785. Moreover,
Michael Cronin, Esq., Tarcon’s attorney at the law firm
Moore & Van Allen, also was familiar with the transaction
and never saw any reason the Former Shareholders should not
enter the transaction with MidCoast. And when the Former
Shareholders asked Cherry and their attorneys whether the
deal was legitimate, they were told that it was, and that Mid-
Coast had "done these [deals] before." J.A. 801. These con-
versations led the Former Shareholders to be "confident" that
the deal was "legitimate" and "completely legal." J.A. 725,
801.
Furthermore, the Tax Court was entitled to weigh other cir-
cumstantial evidence bearing on the issues of "reasonable dili-
gence" and constructive knowledge. Specifically, although the
Former Shareholders had substantial experience in the freight
consolidation business and some warehouse leasing experi-
11
Indeed, Cherry was appropriately circumspect throughout, writing as
follows to the Former Shareholders when he received MidCoast’s initial
communication:
[I]t appears that this is something that they do often, but also
something in which I am definitely out of my league. I would like
to encourage you, when the time is appropriate, to involve both
your accountant and a lawyer to help advise us through this trans-
action should it move forward.
101 T.C.M. (CCH) 1283, 2011 WL 894608, at *2. Obviously, the Former
Shareholders acted on this sage advice.
34 STARNES v. CIR
ence, none had ever sold a business before, and none had any
education, training, or experience in accounting, taxes, or
finance. Naples and Starnes each had a high school education;
Morelli a ninth-grade education. They each worked at Tarcon
for all or nearly all of their adult lives—Morelli began assist-
ing on the docks, Starnes as a janitor. In sum, the Tax Court
could reasonably find, as it essentially did, that the Former
Shareholders learned what any reasonably diligent inquiry
would have disclosed to any similarly situated group of per-
sons through their reliance on their advisors and agents.
For these reasons, we conclude the Tax Court did not com-
mit clear error in finding that the Commissioner failed to
prove that a reasonably diligent person in the Former Share-
holders’ position would have learned that, as a result of the
transaction, Tarcon would fail to pay its 2003 taxes. Given
that factual finding, the Commissioner failed to prove that the
December 1 transfer—which rendered Tarcon essentially
insolvent and unable to satisfy its 2003 tax liability—should
be collapsed with the earlier transfers for purposes of deter-
mining whether Tarcon received "reasonably equivalent
value" in the "transfer," as required by N.C. Gen. Stat. § 39-
23.5.12 Because the transfers were not collapsible under North
Carolina law, they were not fraudulent under § 39-23.5 with
respect to the Former Shareholders. Accordingly, the Tax
Court properly held that § 39-23.5 does not provide a basis for
holding the Former Shareholders liable for Tarcon’s 2003 tax
liability.
12
For the same reason, we reject the Commissioner’s argument that the
Tax Court clearly erred in finding there was no "circular flow of funds."
See Appellant’s Br. at 62-65; see also n.5, supra. The Commissioner’s
clear-error argument on that point also boils down to an argument that the
December 1 transfer should have been collapsed with the earlier transfers.
Because the Tax Court did not clearly err in refusing to collapse the trans-
actions, it did not clearly err in finding there was no circular flow of funds.
STARNES v. CIR 35
2.
The next NCUFTA provision the Commissioner argues
rendered fraudulent the transfer of Tarcon’s assets as to the
Former Shareholders is N.C. Gen. Stat. § 39-23.4(a)(2).
Under that subsection, a "transfer" made by a debtor "is fraud-
ulent as to a creditor" if the debtor (1) made the transfer
"without receiving a reasonably equivalent value in
exchange," and (2) was engaged in a transaction for which its
"remaining assets" were "unreasonably small," or intended to
incur "debts beyond the debtor’s ability to pay." Id. As
explained in the preceding section, the Commissioner failed
to prove the December 1 transfer should be collapsed with the
November 13-14 transfers for NCUFTA purposes. Thus, just
as under § 39-23.5, the Commissioner failed to prove Tarcon
did not receive "reasonably equivalent value" for its cash.
Accordingly, § 39-23.4(a)(2) does not provide a basis for
holding the Former Shareholders liable as transferees for Tar-
con’s 2003 taxes.
3.
The third and last NCUFTA subsection the Commissioner
relies upon is N.C. Gen. Stat. § 39-23.4(a)(1). That subsection
provides that a transfer made by a debtor is fraudulent as to
a creditor if the debtor made the transfer "[w]ith intent to hin-
der, delay, or defraud any creditor of the debtor." Id. The stat-
ute provides thirteen non-exclusive "factors" for determining
whether a debtor had the requisite fraudulent intent. The Tax
Court considered seven of them relevant to the facts here:
(1) The transfer or obligation was to an insider;
...
(5) The transfer was of substantially all the debt-
or’s assets; . . .
(7) The debtor removed or concealed assets;
36 STARNES v. CIR
(8) The value of the consideration received by the
debtor was reasonably equivalent to the value
of the asset transferred or the amount of the
obligation incurred;
(9) The debtor was insolvent or became insolvent
shortly after the transfer was made or the obli-
gation was incurred;
(10) The transfer occurred shortly before or shortly
after a substantial debt was incurred; . . .
(12) The debtor made the transfer or incurred the
obligation without receiving a reasonably
equivalent value in exchange for the transfer
or obligation, and the debtor reasonably
should have believed that the debtor would
incur debts beyond the debtor’s ability to pay
as they became due[.]
Id. § 23.4(b).13
13
The other factors are the following:
(2) The debtor retained possession or control of the property
transferred after the transfer;
(3) The transfer or obligation was disclosed or concealed;
(4) Before the transfer was made or obligation was incurred, the
debtor had been sued or threatened with suit; . . .
(6) The debtor absconded; . . .
(11) The debtor transferred the essential assets of the business
to a lienor who transferred the assets to an insider of the
debtor; . . .
(13) The debtor transferred the assets in the course of legitimate
estate or tax planning.
N.C. Gen. Stat. § 39-23.4(b).
STARNES v. CIR 37
The Tax Court weighed these factors and held that the
Commissioner had not shown that the Shareholders intended
to hinder, delay, or defraud the IRS, which was, after all, Tar-
con’s only creditor at the time. Crucial to its analysis was its
rejection of the Commissioner’s argument for collapsing the
November 13-14 and December 1 transfers, a conclusion we
affirm for the reasons explained above. Because the relevant
time frame is limited to November 13-14, the transfer was not
of substantially all of Tarcon’s assets (factor 5); Tarcon did
not remove or conceal assets (factor 7); the value of the con-
sideration Tarcon received was "reasonably equivalent to the
value of the asset transferred" (factor 8); Tarcon was not ren-
dered insolvent (factor 9); and Tarcon did not make the trans-
fer "without receiving a reasonably equivalent value in
exchange" (factor 12). Thus, although the Former Sharehold-
ers were "insiders" (factor 1) and the transfers occurred
shortly after a substantial debt, namely the tax liability on the
warehouse sale, was incurred (factor 10), the Tax Court con-
cluded the Commissioner had not shown that the Former
Shareholders intended to "hinder, delay, or defraud" the IRS
from collecting Tarcon’s 2003 taxes.
On appeal, the Commissioner argues the Tax Court erred
in applying these factors for largely the same reason the court
erred on the other claims: by requiring evidence of actual or
constructive knowledge that Tarcon would be rendered insol-
vent by the transaction. For the reasons stated above, that was
not legal error. And the Tax Court did not clearly err in mak-
ing the factual findings underlying the conclusion that the
Former Shareholders did not intend to hinder, delay, or
defraud the IRS from collecting Tarcon’s 2003 taxes. There-
fore, the Commissioner has failed to show that § 39-
23.4(a)(1) renders the Former Shareholders liable for Tar-
con’s 2003 taxes.
4.
Lastly, the Commissioner argues the Former Shareholders
are liable to Tarcon’s creditors under the common law "trust
38 STARNES v. CIR
fund doctrine." This doctrine treats the assets of a corporation
as, "in a sense, . . . a trust fund," and the corporation’s officers
and directors as "occupy[ing] a fiduciary position in respect
to stockholders and creditors, which charges them with the
preservation and proper distribution of those assets." Snyder
v. Freeman, 266 S.E.2d 593, 601 (N.C. 1980). "The corporate
debts must be paid before [officers and directors] can appro-
priate any part of the assets to their own use, though they may
also be stockholders." McIver v. Young Hardware Co., 57
S.E. 169, 171 (N.C. 1907). "[T]he stockholders and officers
of the corporation are liable to it and to its creditors for any
acts of malfeasance, misfeasance, or nonfeasance by which
their rights are injuriously affected, and, as a consequence, for
any loss arising out of their fraud or negligence." Id.
The Tax Court rejected this argument because (1) as a legal
matter, the trust-fund doctrine only applies "where circum-
stances exist ‘amounting to a winding-up or dissolution of the
corporation,’" Starnes, 101 T.C.M. (CCH) 1283, 2011 WL
894608, at *13 (quoting Whitley v. Carolina Clinic, Inc., 455
S.E.2d 896, 899–900 (N.C. Ct. App. 1995)), and (2) as a fac-
tual matter, the Commissioner "has not presented evidence
regarding circumstances that existed amounting to a winding
up or dissolution of Tarcon aside from claiming that Tarcon
no longer had a business activity." Id.
On appeal, the Commissioner does not dispute the Tax
Court’s characterization of North Carolina law, limiting the
trust-fund doctrine to the dissolution context. Rather, the
Commissioner argues the court’s finding that Tarcon was not
in dissolution was clearly erroneous. We disagree. At the time
the Former Shareholders entered the transaction, MidCoast’s
representatives assured them that Tarcon would remain a
going concern and would be absorbed into MidCoast’s "asset
recovery" business. Indeed, Tarcon did remain in existence
long past the time MidCoast bought its stock. Just as it was
not clearly erroneous to find that the Former Shareholders did
not know the transaction would leave Tarcon insolvent, it was
STARNES v. CIR 39
not clearly erroneous to find that the transaction did not
amount to a winding up or dissolution of the company.
III.
As we have explained at length, the Commissioner’s efforts
to collect Tarcon’s unpaid 2003 taxes from the Former Share-
holders foundered on his inability to persuade the Tax Court
that the Former Shareholders knew or should have known that
Tarcon would fail to pay its taxes under its new owner. The
Commissioner argues, as a policy matter, that requiring that
he prove actual or constructive knowledge "imposes an
impossible burden on [him] in intermediary tax shelter cases"
and "enables participants in an intermediary tax shelter to eas-
ily defeat transferee liability, by choosing willful blindness of
the promoter’s tax-avoidance intentions and then claiming
ignorance of the ‘entire scheme.’" Appellant’s Br. at 54-55.
Although we are not unsympathetic to the Commissioner’s
concerns, his policy argument is foreclosed by existing law
for the reasons discussed above. It is also overblown. North
Carolina law, like the law of other states that have adopted the
Uniform Fraudulent Transfer Act, requires neither evidence of
actual intent to defraud nor direct evidence of alleged trans-
ferees’ knowledge. The Commissioner could have prevailed
based solely on circumstantial evidence that the Former
Shareholders should have known of MidCoast’s intentions.
That the Commissioner could not persuade the Tax Court
does not mean his burden was insurmountable; it simply
means his evidence was insufficient to persuade the fact
finder in this case.14 Furthermore, as noted above, the IRS
14
Indeed, with evidence of a more persuasive character, or with histori-
cal facts more compelling, the Commissioner has prevailed before the Tax
Court in other transferee liability cases involving MidCoast. See, e.g.,
Feldman v. Commissioner, 102 T.C.M. (CCH) 612, 2011 WL 6781006
(2011); CHC Industries, Inc. v. Commissioner, 101 T.C.M. (CCH) 1148,
2011 WL 320887 (2011). In each such case, as in this case, the primacy
40 STARNES v. CIR
itself has recognized that a person should only be held liable
in intermediary transaction tax shelter cases if he or she knew
or had reason to know that the transaction was structured to
avoid federal taxes due on assets with built-in gains. See n.3,
supra (citing I.R.S. Notice 2008-111).
Ultimately, as the Commissioner had the burden of proof
on the dispositive issues, his "clear error" contentions before
us really amount in substance to an argument that he is enti-
tled to judgment as a matter of law, i.e., that the evidence of
the Former Shareholders’ foreknowledge of the MidCoast
scheme was so one-sided that no reasonable decision-maker
could reasonably rule in their favor. Manifestly, for the rea-
sons we have explained, this is not so. Therefore, we affirm
the judgment of the Tax Court in favor of the Former Share-
holders.
AFFIRMED
WYNN, Circuit Judge, dissenting:
This case involves a straightforward transaction made com-
plicated so as to facilitate the fraudulent avoidance of a tax
liability. Simply put, the petitioners, former shareholders of
Tarcon, reduced the sole asset of Tarcon to cash by selling
that asset, a warehouse, for $3,180,000. After that October 30,
2003 sale, Tarcon had $3,091,955 in its bank account and no
of the Tax Court’s role as fact finder is, of course, undisputed. To para-
phrase the Supreme Court’s statement of the principle in an analogous
context, "the trial court’s decision on the ultimate question of [fraudulent]
intent represents a finding of fact of the sort accorded great deference on
appeal." Hernandez v. New York, 500 U.S. 352, 364 (1991) (plurality
opinion). Application of that principle here means that although there may
have been some evidence of what the Commissioner calls "willful blind-
ness," it was for the Tax Court, not this court, to make findings based on
that evidence, and we are obliged to accord those findings "great defer-
ence." Id.
STARNES v. CIR 41
tangible assets. As a result of the warehouse sale, Tarcon
incurred a federal tax liability of $733,699 and a North Caro-
lina tax liability of $147,931, for a total of $881,628. If the
story had ended there, the four former shareholders, each of
whom owned 25 percent of Tarcon, would have completed
the liquidation of Tarcon by paying those tax liabilities and
dividing the remaining sum, allowing each to receive a distri-
bution of approximately $552,582.
Of course, the story doesn’t end there. Instead, MidCoast
entered with a fraudulent scheme that would allow the former
shareholders to avoid paying their $881,628 tax liability.
Under its proposal, MidCoast would pay the former share-
holders $2,621,136 for their Tarcon stock and legal fees; in
return, Tarcon would transfer its sole asset, roughly $3.1 mil-
lion in cash, to MidCoast. Why, though, would the sharehold-
ers turn over Tarcon’s $3.1 million to MidCoast and receive
only $2.6 million in return?
The answer is evident when Tarcon’s outstanding tax liabil-
ities of $881,627 are factored into the equation. Indeed, it then
becomes clear that the former shareholders actually negoti-
ated to be paid $2.6 million in cash—for cash that in reality
totaled only $2,210,425,1 resulting in a windfall of $410,711.
That windfall was, in fact, a cut from Tarcon’s $881,627 tax
liability, transferred to MidCoast when it purchased the for-
mer shareholders’ stock, and which it undoubtedly was
scheming to avoid under the guise of offering an "asset recov-
ery premium." While I recognize the intricacies of Mid-
Coast’s subsequent actions to avoid paying the full liability of
$881,627,2 this transaction cannot escape its ultimately simple
1
Tarcon’s $3.1 million in cash, less its tax liabilities of $881,627, equals
$2,210,425 in cash—the true value of Tarcon’s assets.
2
The record reflects that less than two weeks after MidCoast purchased
Tarcon’s stock from the former shareholders, it resold the stock to Sequoia
Capital, LLC, a Bermuda company, for approximately $2.8 million. Two
days after that, the $3.1 million in Tarcon’s account was transferred to
42 STARNES v. CIR
label: a transparent scam designed by the parties to fraudu-
lently evade paying taxes. Accordingly, I must respectfully
dissent.
I.
This is a case about transferee liability under 26 U.S.C.
§ 6901. As such, I take issue with the majority’s conclusion
that it need not address the threshold question of whether the
former shareholders are in fact transferees. The majority dis-
misses as "immaterial," ante at 20, what I view as a critical
analytical difference between the substantive state law in
Kentucky at issue in Commissioner v. Stern, 357 U.S. 39
(1958), and the North Carolina Uniform Fraudulent Transfer
Act (NCUFTA), N.C. Gen. Stat. § 39-23.1 et seq., that con-
trols in this case.
In Stern, the question of whether the beneficiary widow
was a transferee was irrelevant under Kentucky law, as she
would not have been liable in either instance for her deceased
husband’s unpaid income tax deficiencies. Stern, 357 U.S. at
45-46. In this case, by contrast, and as noted by the majority
opinion, North Carolina law may indeed impose liability on
the former shareholders, but only if there was a fraudulent
transfer and they are transferees under federal law. See, e.g.,
N.C. Gen. Stat. §§ 39-23.4, 39-23.5 (voiding certain types of
another account, also in Tarcon’s name, with Deutsche Bank AG. On
December 1, 2003, over $2.9 million of those funds was transferred to an
account in the Cook Islands in the name of Delta Trading Partners, and an
additional $126,822 was transferred to a MidCoast bank account.
After that date, Tarcon never had more than $132,320 in any bank
account. When the company filed its 2003 federal income tax return, it
reported an overall loss and no tax due, based on losses from a purported
interest rate swap option and an asset acquired on December 29 and sold
on December 31, 2003, offsetting the gains from the sale of the warehouse
to ProLogis. The return also stated that the $132,320 represented Tarcon’s
sole asset.
STARNES v. CIR 43
transfers as fraudulent, which under § 6901 would in turn
allow for the imposition of substantive liability on the trans-
ferees in such transactions).
Equally significant, the question of whether the former
shareholders are transferees is inextricably linked with, and
informed by, which transaction is under review. In another
significant distinction from Stern, there was no dispute in that
case that a transfer from the original taxpayer to the benefi-
ciary widow had occurred; here, however, depending on
which transaction is considered, there was no transfer from
Tarcon, the debtor owing taxes. Put another way, for § 6901
and Stern to apply and North Carolina law to determine the
former shareholders’ liability, the former shareholders must
be transferees—but they are only transferees if they received
a "transfer" as part of the transaction under review.
Notwithstanding these material distinctions, the majority
opinion, relying on Stern, assumes arguendo that the former
shareholders are transferees—but then proceeds to analyze the
stock sale between MidCoast and the former shareholders as
the sole transaction relevant under North Carolina law. The
problem, of course, is that the "form" of that transaction was
structured such that the former shareholders received Tar-
con’s assets only indirectly: there was no direct "transfer"
between Tarcon and the former shareholders. As such, the
majority reviews a transaction in which the former sharehold-
ers are not actually transferees, while assuming that they are,
an internal inconsistency in which I cannot concur.3
3
The majority opinion disputes the contention that § 6901 requires
courts to determine, when it may not be properly assumed, the threshold
issue of whether a person or entity is a "transferee" under federal law for
the purposes of § 6901. According to the majority opinion, this question
must be answered—if at all—by reference to state substantive law. How-
ever, if this is the case, why then is "transferee" specifically defined by
federal law to include a "donee, heir, legatee, devisee, and distributee." 26
U.S.C. § 6901(h). A logical application of the majority opinion would
allow state substantive law to redefine, for instance, donees and heirs as
something other than potential transferees in clear contravention of
§ 6901(h).
44 STARNES v. CIR
II.
In my view, the Tax Court and this Court must make the
threshold determination of which transaction is properly
under review, which in turn informs the dispositive issue here
of whether the former shareholders are properly characterized
as transferees under § 6901. See generally Frank Lyon Co. v.
United States, 435 U.S. 561, 581 n.16 (1978) ("The general
characterization of a transaction for tax purposes is a question
of law subject to review."); Va. Historic Tax Credit Fund
2001 LP v. Comm’r of Internal Revenue, 639 F.3d 129, 142
(4th Cir. 2011) (same).
A.
To answer that initial question, I look to this Court’s prece-
dent:
A taxpayer may not . . . claim tax benefits that Con-
gress did not intend to confer by setting up a sham
transaction lacking any legitimate business purpose,
or by affixing labels to its transactions that do not
accurately reflect their true nature. Accordingly,
under the "economic substance doctrine," a transac-
tion may be disregarded as a sham for tax purposes
if the taxpayer "was motivated by no business pur-
poses other than obtaining tax benefits" and "the
transaction has no economic substance because no
reasonable possibility of a profit exists." Rice’s
Toyota World, Inc. v. Comm’r, 752 F.2d 89, 91 (4th
Cir. 1985). Similarly, the doctrine of "substance over
form" recognizes that the substance of a transaction,
rather than its form, governs for tax purposes. See,
e.g., W. Va. N. R.R. Co. v. Comm’r, 282 F.2d 63, 65
(4th Cir. 1960) ("It is well settled that in matters of
taxation substance rather than form prevails and that
the taxability of a transaction is determined by its
STARNES v. CIR 45
true nature rather than by the name which the parties
may use in describing it.").
BB&T Corp. v. United States, 523 F.3d 461, 471 (4th Cir. 2008).4
We have further instructed that "[i]n applying the doctrine of
substance over form, we ‘look to the objective economic real-
ities of a transaction rather than to the particular form the par-
ties employed.’" Id. at 472 (quoting Frank Lyon, 435 U.S. at
573 (alteration omitted)).
Here, the "objective economic realities" establish that the
former shareholders effectively wound up Tarcon and
received liquidating distributions of its cash as a result of the
stock sale to MidCoast. As noted in the Tax Court’s Memo-
randum, it is undisputed that "[b]y 2003, Tarcon was no lon-
ger in the freight consolidation business, and its primary
business was leasing warehouse space" at a property in Char-
lotte.5 Starnes v. Comm’r of Internal Revenue, T.C. Memo
2011-63. 2011 WL 894608, *1 (2011). Thus, the transaction
to sell the warehouse to ProLogis reduced all of Tarcon’s
assets to cash, with no apparent plan to use those monies to
commence another business activity. The Share Purchase
Agreement also explicitly acknowledged that "[i]mmediately
prior to the Closing and at Closing, the Company shall pos-
sess assets consisting of cash in an amount not less than the
sum of $3,092,052.54, and the Company shall be subject to no
4
Although federal law generally controls which transaction gives rise to
the original debtor’s federal tax liability, I note that North Carolina also
incorporates substance-over-form principles in its fraudulent-conveyance
law. See N.C. Gen. Stat. § 39-23.1(12) & N.C. Comment (defining "trans-
fer" for NCUFTA purposes as "every mode, direct or indirect . . . of dis-
posing of or parting with an asset"); Havee v. Belk, 775 F.2d 1209, 1219
(4th Cir. 1985) (holding that substance of a transaction, not its form, gov-
erns for NCUFTA).
5
During the relevant time period, this warehouse was Tarcon’s sole
remaining asset; other assets including a number of luxury cars and a con-
dominium were either sold prior to the transactions at issue or are other-
wise immaterial to the analysis.
46 STARNES v. CIR
Liabilities other than the Deferred Tax Liability" of
$881,627.74. J.A. 249.6 By their own admission, the former
shareholders had decided to retire and sell either Tarcon’s
assets or its stock, effectively liquidating the company.
However, after being contacted by MidCoast, the former
shareholders agreed to sell their stock directly to MidCoast.
This decision was surely driven by MidCoast’s representa-
tions, as outlined in the majority opinion, that "[w]ith a liqui-
dation, the Former Shareholders would effectively be taxed
twice," whereas "[w]ith a stock sale, they would only be taxed
once." Ante at 7. Indeed, it is undisputed that "negotiations
primarily focused on the percentage applied to the tax liabili-
ties to determine the share purchase price."7 Starnes, T.C.
Memo 2011-63, 2011 WL 894608, at *3 (emphasis added).
Even more telling, the Share Purchase Agreement included
the condition that "[t]he Company . . . deliver( ) to [Mid-
Coast] . . . all of the Company’s monies by wire transfer . . .
in the amount of" $3,092,052.54. J.A. 249 (emphasis added).
There was no discernible "legitimate business purpose" for
this transfer of Tarcon’s cash to MidCoast; at closing, Mid-
Coast already had complete control over all of Tarcon’s assets
and accounts by virtue of its ownership of all of Tarcon’s
shares.
Based on these objective realities—and despite its
"form"—the sale to MidCoast was not a true sale of stock.
Rather, the "substance" of the transaction reflects that the pur-
ported sale was no more than a cash-for-cash swap in which
6
Citations to the joint appendix are abbreviated as "J.A."
7
This so-called "asset recovery premium," in which MidCoast paid the
shareholders 43.75 percent of Tarcon’s deferred tax liability, explains why
the former shareholders would enter into the Share Purchase Agreement
at all, rather than simply divide and distribute Tarcon’s $3.1 million in
cash, less the $881,627 in tax liability. Described less charitably, the "asset
recovery premium" sounds quite a bit like a scheme not only to avoid pay-
ing taxes, but to profit while doing so.
STARNES v. CIR 47
the former shareholders received MidCoast’s $2.6 million in
exchange for transferring Tarcon’s $3.1 million. Because cash
is fungible, this exchange is no different in substance than if
the former shareholders had received outright distributions of
Tarcon’s cash. See Owens v. Comm’r of Internal Revenue,
568 F.2d 1233, 1239 (6th Cir. 1977) (explaining that "when
a corporation owns just cash . . . the corporation has already
been effectively liquidated[.]"); Lowndes v. United States, 384
F.2d 635 (4th Cir. 1967) (disregarding a purported sale of
stock in four subsidiaries of Bethlehem Steel Company that
had ceased operating and held only cash). In Owens, the Sixth
Circuit explained that:
In view of these circumstances of the sale, . . . [the
purchasers] did not assume the risks of a business.
What taxpayer actually sold . . . was the right to dis-
tribute a quantity of cash to themselves. Moreover,
that right to a distribution of cash was in substance
no different than the cash that taxpayer received for
the stock. Exclusive control of [the company] was
transferred to [the purchasers]. There were no obsta-
cles to the immediate withdrawal of the cash in [the
company’s] bank account. [The purchasers] were
given the right to draw on the [company’s] bank
account in return for taxpayer being given the right
to draw on [the purchaser’s] bank account. The par-
ties were simply exchanging cash.
568 F.2d at 1240 (internal citations omitted). This type of
exchange of cash, which "does not affect a taxpayer’s benefi-
cial interest," "serve[s] no other purpose than tax avoidance."
Id. (citing Haberman Farms, Inc. v. United States, 305 F.2d
787 (8th Cir. 1962)); see also Rice’s Toyota World, Inc. v.
Comm’r of Internal Revenue, 752 F.2d 89, 91 (4th Cir. 1985)
(holding that the form of a transaction may be disregarded as
a sham for tax purposes if the taxpayer "was motivated by no
business purposes other than obtaining tax benefits").
48 STARNES v. CIR
B.
Having determined that the relevant transaction for review
is not the stock sale, but the effective liquidation of Tarcon,
the next issue for consideration is whether, with respect to
that transaction, the former shareholders are "transferees"
within the meaning of § 6901. If they are, then North Carolina
law applies to determine the "existence and extent" of their
liability. Stern, 357 U.S. at 45.
Under § 6901, a "transferee of property" is liable for
income taxes "in the same manner and subject to the same
provisions and limitations as in the case of the taxes with
respect to which the liabilities were incurred" by the taxpayer.
26 U.S.C. § 6901(a). A "transferee" is further defined as
including a "donee, heir, legatee, devisee, and distributee." Id.
§ 6901(h). Again, because cash is fungible, the former share-
holders effectively received distributions of Tarcon’s assets
during liquidation, with MidCoast as a mere conduit. As such,
the former shareholders meet the definition of "transferees."
Moreover, because the Share Purchase Agreement did not
require that Tarcon get anything in return for its $3.1 million,
this transfer was plainly fraudulent under North Carolina law,
as it cannot fairly be said that it "receiv[ed] a reasonably
equivalent value in exchange for the transfer." N.C. Gen. Stat.
§ 39-23.5(a); In re Jeffrey Bigelow Design Grp. Inc., 956 F.2d
479, 484 (4th Cir. 1992) ("What constitutes reasonably equiv-
alent value is determined from the standpoint of the debtor’s
creditors." (quotation and citation omitted)). Moreover, until
MidCoast voluntarily moved the $3.1 million back into a new
Tarcon account the following day, Tarcon did, albeit tempo-
rarily, "bec[o]me insolvent as a result of the transfer." N.C.
Gen. Stat. § 39-23.5(a).
The majority opinion dismissively refers to the transfer
from Tarcon to MidCoast as an "apparent mistake" and a tem-
porary "detour" of Tarcon’s cash, ante at 11, apparently
STARNES v. CIR 49
because, although the $3.1 million was initially transferred
into MidCoast’s account, it was returned to Tarcon’s post-
closing account the next day, per the closing statement. Not-
withstanding what the closing statement may have said or
what happened the next day, it is undisputed that the Share
Purchase Agreement required only that Tarcon to deliver all
of its cash to the trust account of MidCoast’s attorneys.8 As
a result, the critical transfer here was from Tarcon to Mid-
coast, with nothing required to be returned to Tarcon under
the express terms of the Share Purchase Agreement.
Even if one assumes, as the majority does, that MidCoast
was required to transfer the $3.1 million back to Tarcon, such
that Tarcon did receive value, the transfer from MidCoast to
the shareholders must also be voided as fraudulent under
North Carolina law, and the former shareholders would like-
wise be liable as transferees. Under that approach, because
MidCoast became the debtor when it assumed Tarcon’s tax
liabilities by purchasing all of its outstanding shares of stock,
its transfer of $2.6 million to the former sharehold-
ers—including the "asset recovery premium"—was made
with "intent to hinder, delay, or defraud" the IRS.9 N.C. Gen.
Stat. § 39-23.4(a)(1). In other words, the former shareholders
would be liable as "transferees of transferees," as Tarcon
transferred its liabilities to MidCoast, and MidCoast in turn
8
Indeed, the movement of Tarcon’s cash—from a Tarcon account, to a
MidCoast account, back to a Tarcon account—is strongly suggestive of
MidCoast’s leveraging those funds to finance its payment to the former
shareholders. At the least, it calls into question whether the Tax Court was
correct in its determination that this deal did not involve a circular flow
of funds.
9
This "intent to hinder" is illustrated by the realities that: (a) the shares
of stock received by MidCoast, with an actual value of only $2.2 million,
cannot fairly be said to be "reasonably equivalent" to the $2.6 million that
was paid; and (b) by paying the "asset recovery premium" to the share-
holders, MidCoast reduced its ability to pay Tarcon’s tax liability. See
N.C. Gen. Stat. § 39-23.4(b)(1) (outlining factors that would show "intent"
under the previous section).
50 STARNES v. CIR
transferred cash to the former shareholders. See Butler v.
Nationsbank, N.A., 58 F.3d 1022, 1026-28 (4th Cir. 1995)
(finding that indirect transfer was a fraudulent conveyance
under predecessor law to NCUFTA).
III.
The record here shows that the former shareholders did not
understand what was meant by the "asset recovery business"
or what MidCoast actually planned to do with Tarcon, yet
they made no inquiries in part because "it wasn’t something
[they] wanted to understand," and MidCoast could do what it
wanted with Tarcon once they were paid for their stock. J.A.
824. Faced with a windfall of over $410,000, the former
shareholders’ willful blindness is somewhat understand-
able—but it cannot be allowed to stand, lest this type of sham
transaction to avoid paying federal taxes becomes a standard
business practice.
When the substance, rather than the form, of these transac-
tions is properly reviewed, it becomes clear that the deal in
question was nothing more than a new, more sophisticated
version of money laundering. Because I find that the "eco-
nomic realities" here amounted in substance to a distribution
of Tarcon’s cash, less only roughly half of its deferred tax lia-
bilities, to the former shareholders, with a facilitation fee paid
to MidCoast, I would reverse the Tax Court and find the for-
mer shareholders liable as transferees under § 6901 and North
Carolina law. Accordingly, I respectfully dissent.