IRS Can Collect Taxes From You Owed By Someone Else

It seems bad enough that you have to pay your own taxes, let alone someone else’s. But it can happen. The IRS sometimes comes after one taxpayer to collect the tax liability of someone else. How is this possible, you might wonder? The answer is “transferee liability,” a concept embodied in Section 6901 of the tax code. Actually, the concept has deep roots in legal history. In fact, it is a creditor protection device going back hundreds of years. Essentially, the IRS can pursue a “transferee”—someone who received assets or money for less than full and fair value from the taxpayer. You might think of it as kind of a stolen property rule.

Example: Uncle Johnny owes the IRS a pile of money. He gives you his Mercedes. You may enjoy driving it and may have no idea Johnny owes the IRS. Even so, the IRS may be able to repossess it. The IRS claim on the Mercedes trumps yours, even if you didn’t know about the taxes. The result is the same if you paid Johnny $5,000 for it but the car is really worth $20,000.

As with everything else in the tax code, applying these rules isn’t simple, and procedure and timing are both important. First a bit of nomenclature. The person owing taxes is the “transferor,” and the person being pursued the “transferee.” There are two bases of transferee liability: at law and in equity. You are liable as a transferee at law when you are responsible for the transferor’s tax liability by contract. The IRS must prove the tax liability was within the terms of the contract. In some cases, this arises by statute, such as in corporate mergers.

The great majority of transferee liability cases involve claims in equity. You are liable as a transferee in equity when you receive the transferor’s assets for less than full, fair and adequate consideration and leave the transferor insolvent and unable to pay the tax liability.  An example is the Mercedes your Uncle Johnny gave you. You got it for free, or for a bargain price, so you are on the hook. Your liability is limited to the value of the assets you received. To collect, the IRS must prove five elements:

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