The California State Board of Equalization (SBOE) recently upheld a Franchise Tax Board (FTB) tax assessment against an individual member of a LLC using the theory of transferee liability. On appeal, the SBOE sustained the FTB's decision, finding the individual appellant liable for the insolvent transferor’s tax liabilities because there was a transfer of taxpayer property to a third-party and the taxpayer-transferor was liable for the tax at the time of the transfer.
The LLC, which had been doing business in California, was dissolved and liquidated pursuant to a settlement and mutual release agreement entered into by the three individual members of the LLC on July 19, 2012. The LLC filed a return for the 2012 tax period that included reported tax liability of $6,800, with asset and year-end capital totals of $0. Pursuant to the settlement agreement, the individual appellant received one half of the LLC’s assets, including accounts receivable valued at $19,620 and a withdrawal or distribution totaling $196,125. The appellant also agreed to pay the other two members of the LLC $220,000 for the LLC's website and trademark. The appellant, however, did not pay the LLC anything pursuant to the settlement agreement.
The FTB issued a Notice of Proposed Assessment to the appellant as transferee for the unpaid tax liability incurred by the LLC, and on appeal the appellant took issue with the FTB’s determination that he was the transferee of the LLC. The appellant argued that in order to be considered a transferee he must receive property from the transferor for less than full and adequate consideration, and that the assets he received—“‘existing direct-dial phone numbers, furniture, certain computers and servers along with their software, accounts receivable and two websites’”—had almost no value. The appellant stated that his motive was not to receive assets from the LLC but, instead, to remove himself from a “burdensome corporate agreement” with the other LLC members. He further contended that agreed upon withdrawals and distributions totaling $196,125 were never received, forcing him into bankruptcy.
Before the SBOE, the FTB argued that the appellant was liable as a transferee in equity because the LLC had transferred all its assets to its members, including appellant, and the LLC received nothing in return. That transfer, the FTB argued, left the LLC insolvent and unable to pay its tax liabilities.
The SBOE sustained the FTB’s determination of transferee liability, emphasizing in its decision that transferee liability does not create a new tax liability for the transferee, but merely, “provides an alternative means to enforce an existing liability.” The appellant, in his haste to remove himself from the LLC, failed to provide the corporate entity with any consideration for assets received. Corporate assets and consideration for those assets was divided amongst the members, rendering the LLC insolvent, and making the appellant liable for the taxes it owed.
The decision is a reminder for practitioners and business owners alike that states will vigorously pursue members of an LLC or other business entity for its tax debts and that members cannot contract around that liability.
Continue the conversation on Bloomberg BNA's State Tax Group's LinkedIn page: Did the SBOE reach the right decision when it determined there was no consideration given to the corporation for assets received by the member?
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