What is a Fraudulent Transfer?

What is a Fraudulent Transfer?

Fraudulent Transfers of Assets

What is a Fraudulent Transfer: When a US person owes money to the Internal Revenue Service, the IRS will put the Taxpayer on notice of the debt, assess the amount due — and then if payment is not received — will pursue filing a public notice referred to as an NFTL (Notice of Federal Tax Lien). Especially in a situation in which taxpayer disputes the amount due and has no intent of paying the IRS, having an NTFL on file can be tough to circumvent. Oftentimes, the asset that is the most crucial is the Taxpayer’s home or residence. If the taxpayer believes that a Notice of Federal Tax Lien may be coming down the pipeline, they may seek to transfer the property solely to avoid tax — the asset then transfers to a third party, who then sells the asset which can escape the federal tax lien because it was not in the Taxpayer’s name at the time the public notice was filed (or anytime after). If this was done for the sole purpose of evading or defeating tax — they may become a tax fraud for tax evasion issue. Let’s take a look at the basics of fraudulent transfers:

Fraudulent Transfer Definition Explained

With a fraudulent transfer, a person transfers an asset to another person, entity, alter ego, etc. for the purpose of avoiding liabilities they may have incurred. For example, a person owes a significant amount of tax to the US government. If a Taxpayer is on notice of a tax liability — and before the public is on notice by way of a Notice of Federal Tax Lien, a person may seek to transfer the property to another person’s name.

Here is a very basic example: David owes $300K to the IRS. He has no plans to pay the amount assessed and is concerned the IRS will lien his house. Therefore, before the IRS files paperwork in that county so that the public is placed on notice of the lien, David transfers the asset (his home) to a third party — which is actually a company that David controls even though he is not named as an owner — and then the company sells the property. While the NTFL may still exist in the county where the property and David reside, the home is not under David’s name. So, the sale goes through without having to first “clear title.”

This was a fraudulent transfer, because:

  • David is the owner of the home;
  • David was the only owner of the property;
  • The Corporation is merely an alter ego of David solely designed to receive the property for imminent sale to avoid a lien; and
  • The company sold the asset to avoid alter ego/payment of assessed taxes

Tax Fraud/Evasion for Transferor

If the US Government can show the transfer was designed to evade the payment of tax, then the government may be able to go after the Taxpayer for civil or criminal tax fraud or evasion — but that is not always easy to prove. Possibly, David can show that there was a legitimate reason for the transfer and that the potential NTFL and the actual sale was just “awkward timing.”

Transferee Liability

In this above-referenced situation, the transferee (recipient of the transfer) can be subject to liability as well. The Internal Revenue Manual (IRM) provides a good breakdown of the basics of transferee liability: (05-24-2019)

Fraudulent Transfers and Transferee and Other Third Party Liability

      • Fraudulent Conveyance. The DOJ, on behalf of the IRS, may bring a fraudulent transfer action to set aside the transfer, or in some instances, to obtain a judgment of liability against the transferee.

      • State law.Fraudulent conveyance laws were initially developed by state courts. That common law is reflected now in state statutes based on the Uniform Fraudulent Conveyance Act (UFCA) (proposed in 1918) and the Uniform Fraudulent Transfer Act(UFTA) (proposed in 1984). The liability under these laws is termed “in equity” because of the common law origin. Most states have enacted statutes based on the (UFTA. There are two kinds of fraudulent conveyances that may result in liability “in equity”: those effected though constructive fraud and those effected though actual fraud. See IRM, at (2) and (3), below, respectively. The elements of an action vary state by state even if a statute is based on a uniform act: e.g., a state may change an element provided in the uniform act or retain an element of the common law in its statute. A state might continue to allow an action based on the common law and if so precedent under that common law may make it a preferred alternative to an action based on a statute.

      • Federal law. The Federal Debt Collection Procedures Act of 1990(FDCPA), 28 U.S.C. §§ 3001 et seq., provides a federal cause of action for fraudulent transfers. Provisions regarding fraudulent transfers involving debts are at 28 U.S.C. §§ 3301-3308 (Subchapter D). Section 28 U.S.C. § 3304 provides a remedy similar that provided by the UFTA. For debts arising before a transfer, see 28 U.S.C. § 3304(a) (compare constructive fraud under UFTA), and for transfers without regard to the date the debt arose, see § 3304(b) (compare actual fraud under UFTA). The FDCPA should complement state procedures; but, if not, the Act preempts any state law that is inconsistent with the Act; see 28 U.S.C. § 3003(d).

IRM Constructive Fraud

      • Constructive Fraud— Constructive fraud occurs when a taxpayer (or other person liable for the tax) makes a conveyance and such taxpayer or person is or will be thereby rendered insolvent when the conveyance is made without adequate consideration. Discuss in detail the facts pertaining to:

        • The transfer of assets made when the transferor was liable for the tax. While tax liability arises at the end of the tax year, a transfer made during the tax year may give rise to a contingent tax liability at the time of the transfer in some jurisdictions,

        • The insolvency of the taxpayer as of the date of transfer, or immediately thereafter,

        • The absence of reasonably equivalent value or fair consideration (terminology depends on the statute) in exchange for the transfer, and

        • The value of the assets (fair market value) on the date of transfer, which generally determines the limits of the transferee liability.

IRM Actual Fraud

    • Actual Fraud– Transfer With Actual Intent To Hinder, Delay or Defraud Creditors —- The proof must be clear and convincing to set aside a conveyance on the ground of actual intent to defraud the government. Usually it is impossible to prove actual fraudulent intent by direct evidence because the facts relating to the fraudulent transfer are within the knowledge of the taxpayer or other transferor. Proof of the fraud must, therefore, usually come by inference from circumstances surrounding the transaction and the relationship and interest of the parties thereto. To establish actual intent to defraud creditors, thoroughly analyze and discuss the facts and evidence relating to:

Knowledge of the transferor’s intent by the transferee, the parties involved, and their relationship:

    • Transferee and Other Third Party Liability. State law may provide that in a particular situation the transferor’s tax liability is directly imposed on the transferee. The imposition of liability under these laws is termed “at law.”

    • Bulk sales. Most states have adopted some form of the Uniform Commercial Code (UCC). Article 6 of the UCC governs bulk sales and establishes liability of persons who purchase substantial inventory or equipment from a merchant if certain procedures are not followed.

        • Transfers or distributions leaving the person without enough assets to pay debts.See IRM, Trust Fund Doctrine;IRM, Transferee Liability of a Shareholder or Distributee of a Corporation;IRM, Transferee Liability Directly Imposed on the Transferee (At Law)at “d.” (distributions upon dissolution of corporation).

        • Corporate merger or consolidation statutes.See IRM, Successor Liability of a Corporation as a Transferee.

        • Transfers made as a part of a scheme to avoid debts; e.g., sale of assets to another corporation that is tantamount to a “de facto merger” or a “mere continuation.”See IRM, Successor Liability of a Corporation as a Transferee.

        • Transferee entered into a contract in which the transferee expressly or implicitly agreed to assume the transferor’s tax liability.

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