Salus Mundi Foundation v. CIR

Under 26 U.S.C. § 6901, the two prongs used to establish whether a transferee of a taxpayer’s assets is liable for the taxpayer’s failure to pay income tax operate independently.

The IRS appeals after the United States Tax Court found that the Salus Mundi Foundation (“Salus Mundi”) was not liable for taxes as a transferee of assets. In 1999, Double-D Ranch, Inc., (“Double-D”) a personal holding company for investment assets of American Home Products Corporation and its major shareholder Richard Diebold, had $319 million in assets. In order for it to receive the tax benefits of a stock sale and the buyer the tax benefits of an asset sale, Double-D sold its shares to Sentinel Advisors, LLC (“Sentinel”) through a “Midco transaction” tax shelter. Sentinel, through Shap Acquisition Corporation II, bought the shares for $309 million. These proceeds were distributed to a marital trust of Double-D and several foundations, including Salus Mundi. In 2006, the IRS issued a notice of tax liability to Double-D as a result of this sale. Because Double-D did not have any assets, the IRS pursued the aforementioned foundations as transferees under 26 U.S.C. § 6901. Section 6901 allows for the assessment of tax liability on transferees of a taxpayer’s assets when the taxpayer owes income tax. There are two prongs to this section: (1) The transferee must be such under Section 6901 and federal law; and (2) the alleged transferee must substantively be liable for the taxpayer’s failure to pay taxes under state law. Salus Mundi and the IRS do not dispute these two requirements, but instead contest the relationship of them. The panel agreed with Salus Mundi in that the two prongs operate independently and should be considered separately. Accordingly, it rejected the IRS’s contention that it can recharacterize the transactions under federal law for purposes of the state law inquiry because the argument was not persuasive enough to rule opposite of other circuits and create an “inter-circuit conflict”.