Defendant IRS Wins Fraudulent Transfer Claim For Debtor S-Corporation's Tax Reimbursements to Shareholders 

Parties:

United States Bankruptcy Court, E.D. Virginia, Alexandria Division., 2012.

In re KENROB INFORMATION TECHNOLOGY SOLUTIONS, INC., Debtor.
H. Jason Gold, Trustee, Plaintiff,
v.
United States of America, (IRS) Defendant.
In re Kenrob Information Technology Solutions, Inc., Debtor.

Attorneys:

Lauren Friend McKelvey, Wiley Rein, LLP, McLean, VA, for Plaintiff. Ari David Kunofsky, U.S. Department of Justice, Tax Division, Washington, DC, for Defendant.

Complete case summary here: https://casetext.com/case/gold-v-united-states-in-re-kenrob-info-tech-solutions-inc-1

Basic Issue:

S Corporations, like Kenrob IT, are pass-through entities that do not pay taxes. The taxes are paid by the shareholders; however, the funds to pay for the taxes come from a distribution made by the corporation. In Kenrob IT's case, distributions were made to the shareholders to pay taxes in April 2007 and April 2008. Shortly after April 2008, Kenrob IT went into Chapter 7 bankruptcy and Jason Gold was appointed trustee. Gold asserted that the distributions made to the IRS were a "fraudulent conveyance" and sought reimbursement from the IRS. Gold argued that the tax reimbursements were made without consideration; in other words, that Kenrob IT did not get anything of value in return for making the tax reimbursements.

Bottom Line Result:

The Court disagreed with the Trustee and found in favor of the IRS. If the Trustee had prevailed, it would have sent shock waves to S Corporation shareholders who would have to be concerned that tax payments to the IRS made from distributions in troubled companies could be recalled. Had the IRS been required to refund the tax payments in this case, they would have certainly sought payment from the Kenrob IT shareholders.

As Jay Adkisson stated in his Forbes article about this case "The lesson here is that what constitutes consideration for a transfer -- usually known in the fraudulent transfer context as "reasonably equivalent value" -- is not always obvious. But it should also be comforting to planners that tax reimbursement arrangements such as these have a chance of surviving scrutiny under a fraudulent transfer analysis. This is not to say that all such arrangements will survive, but if properly structured and documented they have a chance, as here." See Adkisson article here: https://www.forbes.com/sites/jayadkisson/2012/11/01/kenrob-information-the-irs-fights-off-fraudulent-transfer-claim-for-debtor-s-corporations-tax-reimbursements-to-shareholders/#346453913353

Mr. Adkisson was prescient in stating that "This is not to say that all such arrangements will survive..." In the 2016 Zazalli v. Swenson (In re DBSI, Inc.), case (referenced below), the bankruptcy trustee prevailed against the IRS and obtained a $17 million fraudulent transfer judgment for S Corporation tax payments made on behalf of the principals. DBSI, short for Diversified Business Services and Investments managed office buildings, shopping centers and warehouses for investors nationwide. DBSI sold investors fractional interests in the properties, and they leased the properties back to DBSI to manage.The company collapsed into bankruptcy in 2008. Prosecutors said the company had become a Ponzi scheme, with money from new investors used to pay earlier investors.

Key Terms:

Fraudulent conveyance/fraudulent transfer - Two types of fraudulent conveyance exist: actual fraud and constructive fraud. Under 11 U.S.C. Section 548, actual fraud occurs when a debtor intentionally donates or gets rid of property as part of an asset protection scheme. Constructive fraud occurs if a debtor receives less than "reasonably equivalent value" for property that it transfers for the benefit of creditors and if the debtor "was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation." 

https://www.investopedia.com/terms/f/fraudulentconveyance.asp

 

Chapter 7 bankruptcy - A chapter 7 bankruptcy case does not involve the filing of a plan of repayment as in chapter 13. Instead, the bankruptcy trustee gathers and sells the debtor's nonexempt assets and uses the proceeds of such assets to pay holders of claims (creditors) in accordance with the provisions of the Bankruptcy Code. https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-7-bankruptcy-basics

Adequate consideration - Value that is a fair amount for property transferred by a debtor especially in bankruptcy and that is not therefore evidence of a fraudulent conveyance. 

https://www.merriam-webster.com/legal/reasonably%20equivalent%20value

Cases Citing This Case (from casetext.com):

7 Citing Cases.

Gold v. Myers Controlled Power, LLC (In re Truland Grp., Inc.), 2018

Attorneys:

Dylan G. Trache 101 Constitution Avenue, N.W., Suite 900 Washington, D.C. 20001 Counsel for the Plaintiff. James M. McHugh 220 Market Avenue, South, Eighth Floor Canton, Ohio 44702 Counsel for the Defendant.

Gresk v. Bulmer (In re Bulmer), 2017

Attorneys:

None mentioned.

Zazalli v. Swenson (In re DBSI, Inc.), 2016

Attorneys:

Brett S. Theisen, Jennifer A. Hradil, Mark Barry Conlan, Michael F. Quinn, Gibbons P.C., Newark, NJ, Keely E. Duke, Kevin Alan Griffiths, Duke Scanlan & Hall, PLLC, Boise, ID, for Plaintiff. Ari David Kunofsky, Kieran O'Neall Carter, U.S. Department of Justice Tax Division, for Defendants.

LandAmerica Fin. Grp., Inc. v. S. Cal. Edison Co., 2015

Attorneys:

Richard Daniel Scott, Law Office of Richard D. Scott, Roanoke, VA, for Appellant. John Michael Craig, Law Offices of Russell R. Johnson III, Manakin–Sabot, VA, for Appellee.

Official Committee of Unsecured Creditors of SGK Ventures, LLC v. NewKey Group, LLC (In re SGK Ventures, LLC), 2014

Attorneys:

Micah E. Marcus, David A. Agay, Joshua A. Gadharf, McDonald Hopkins LLC, Chicago, IL, for Plaintiff. Marc S. Reiser, Mark L. Radtke, Gordon E. Gouveia, Terence G. Banich, Shaw Fishman Glantz & Towbin LLC, Chicago, IL, for defendant NewKey Group, LLC. Roger J. Higgins, The Law Offices of Roger Higgins, LLC, Chicago, IL, for defendants Deborah S. Newman, Edward J. Newman, Nicholas F. Cerminaro, Jr.

Landamerica Fin. Grp., Inc. v. S. Cal. Edison (In re Landamerica Fin. Grp., Inc.), 2014

Attorneys:

None mentioned.

Crumpton v. Stephens (In re Northlake Foods, Inc.), 2012

Attorneys:

John K. Rezac, Taylor English Duma LLP, Atlanta, GA, Roberta A. Colton, Stephanie Crane Lieb, Trenam Kemker, Tampa, FL, for Appellant. Robert Zebro, Cope, Zebro & Crawford, PL, Clearwater, FL, Steven R. Wirth, Akerman Senterfitt, Tampa, FL, for Appellee.

Kace Clawson served as an expert witness for defendant IRS in this litigation. His primary duties on this engagement included business valuation and solvency analysis. Mr. Clawson specializes in business valuation, forensic accounting and fraud investigation, expert witness services and ESOP trustee/fiduciary services. In the past 35 years, he has provided these services to public and privately held companies in the United States, Mexico, South America, Europe, Asia and Africa. He has currently personally certified to the valuation of over 2,500 business entities and has been accepted as an expert witness in 11 court jurisdictions. Mr. Clawson can be reached at kclawson@bvellc.com or at (703) 593-5214.

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