Minority Shareholders Liable For Part Of Corporate Income Tax

This post was originally published on Forbes Apr 23, 2015

The Tax Court decision in the case of William Kardash and Charles Robb is one of those where the back story is quite a bit more interesting than the decision.  The problems of Mr. Kardash and Mr. Robb are collateral damage in the collapse of Florida Engineered Construction Products Corp (FECP).  Their former boss John D. Stanton currently resides at a low security federal correctional institution in Sumterville FL having been sentenced to 10 years and payment of $37,816,875 in 2013.  According to the DOJ news release

According to evidence presented at trial, Stanton was the former president of Florida Engineered Construction Products Corporation ("FECP"), more commonly known as Cast Crete Corporation. FECP/Cast Crete manufactured and sold concrete construction products. As president of the company, Stanton interfered with the administration of the tax laws by impeding an Internal Revenue Service ("IRS") audit of the company, creating and backdating two fraudulent demand promissory notes totaling $500,000,000, causing false Forms 1099 to be filed with the IRS, failing to file corporate tax returns on behalf of the company, and other acts of obstruction and concealment. During approximately 2004 through 2008, the company made well over $100 million and failed to file a single corporate income tax return.

And then there's the bigamy.  Wow.

Chasing The Little People

Anyway, of the $120,000,000 in tax, interest and penalties racked up by FECP, the IRS was looking for recover a mere $5 million from Mr. Kardash and Mr. Robb.  The concept they are using is something called transferee liability.  The idea is that money that should have gone to pay an entity's taxes that goes to somebody else can be recovered from that somebody else in some circumstances.

One of the things that makes transferee liability complicated is that it involves determinations under state law.  The IRS did not go after the salaries that Mr. Kardah and Mr. Robb had received.  They did, however, go after two other types of payments.

They had been receiving bonuses in addition to their regular salaries, but in 2003, the bonus program was suspended.  Recognizing that this kind of cramped their lifestyle, Mr. Stanton saw that they were given advances in 2003 and 2004.  They did not reflect the advances in their income, although they later were audited on that issue and settled with the IRS.  They never paid interest or signed promissory notes and the advances were forgiven in 2009.

Then there were the dividends.  That was one of the ways Mr. Stanton was getting money out for himself, but Mr. Kardash and Mr. Robb were minority shareholders and entitled to their pro-rata share. Of the over $25 million in dividends paid in 2005, 2006 and 2007, Mr. Kardash received over $3.5 million and Mr. Robb received nearly half a million.

The Decision

The Tax Court ended up deciding that the advances were really compensation, so those were not fair game.  The dividends were a different story.  That made the decision pretty lengthy.  The Tax Court had to consider how solvent the company was when the dividends were paid, which meant dueling experts.

Kardash and Robb tried to argue that the IRS entering into an installment agreement with the corporation and not going hard enough after other transferees let them off the hook, but he Tax Court was not buying that.

The Florida Uniform Fraudulent [*24] Transfer Act (FUFTA) does not require a creditor to pursue all reasonable collection efforts against the transferor.  Therefore, respondent was not required to exhaust collection efforts against FECP, and petitioners may be held liable. 

An analysis of the experts' reports shows that FECP was insolvent for all transfers starting in 2005. It is clear FECP was insolvent once the dividends were transferred to the shareholders beginning in 2005, essentially stripping the company of its assets. Other than the tax liability of FECP, there is no evidence that FECP was not paying its debts as they became due. Further, even with the advance payments in 2003 and 2004, FECP's assets exceeded the fair value of its [*35] debts. However, with the large distributions of money to the shareholders starting in 2005 and the accumulation of the tax liability, FECP's assets did not exceed the fair value of its debts. We find that FECP was solvent for the years 2003 and 2004 and insolvent for the years 2005, 2006, and 2007.

Since the dividends were the larger amounts it seems that the IRS will be recovering much of the $5 million they expected to get from Mr. Kardash and Mr. Robb assuming they are able to pay.

Other Coverage

There was enough other coverage of this case that I was tempted to skip it, but I did find it pretty interesting. At McGladrey, they noted:

The corporate veil exists to protect shareholders from actions taken against the corporation. However, as is seen in Kardash, this protection is not unlimited. Proper capitalization and record keeping, segregation of corporate and personal assets, and following corporate formalities are all requirements necessary to protect the veil. Where significant undercapitalization is present, specifically undercapitalization caused by fraud, the protections afforded by the veil are pierced exposing the shareholders to liability. Taxpayers should take note of the decision in Kardash as it serves as a reminder to respect the separate and distinct nature of the corporate entity.

Of course Kardash and Robb didn't really have any control over those issues.  When Stanton was asked by his accounting staff how to book transfers to his personal account, he told them to mind their own business.

Stephen Olsen at Procedurally Taxing has a long discussion of the details ending with.

  An interesting case, and what seems to be a tough result for some transferees who were screwed by their employer.

I have to agree there.

Jay Freireich concluded

Moral of the story is that anyone receiving funds from an entity that does not pay its taxes can be subject to transferee liability and the recipient of the funds should be sure to document the goods or services provided to the company for which payment is received or risk transferee liability.

Well I guess that is the advantage of getting a little behind.  I get to see what everybody else thinks.