18 T.C. 1159 (1952)

A transferee of property in a fraudulent conveyance is liable for the transferor’s tax liabilities to the extent of the property received and retained, but is not liable for the value of property returned to the transferor prior to a notice of transferee liability.

Summary

Fada Gobins was determined by the IRS to be the transferee of assets from Kay Jelwan, who owed income tax and penalties. Jelwan transferred assets to Gobins while insolvent, with the understanding that she would pay his living expenses. The Tax Court held that Gobins was liable as a transferee to the extent she retained assets, but not for assets she returned to Jelwan before the notice of transferee liability. The court also found that Jelwan’s original tax deficiency was due to fraud.

Facts

Kay Jelwan, facing health issues and potential liabilities, transferred substantially all of his property, including a restaurant business and bank accounts, to Fada Gobins. Gobins and Jelwan had a personal relationship. Jelwan was insolvent after the transfers. Gobins used some of the funds to construct an apartment for Jelwan, pay his medical bills, and purchase bonds in his name. Jelwan later sued Gobins to recover the transferred property, and a settlement was reached where Gobins returned a substantial portion of the assets.

Procedural History

The Commissioner of Internal Revenue determined a deficiency in Jelwan’s income tax and assessed a fraud penalty. The Commissioner then determined that Gobins was liable as the transferee of Jelwan’s assets. Gobins contested both the deficiency against Jelwan and her liability as transferee in the Tax Court.

Issue(s)

1. Whether the Commissioner met the burden of proving that Jelwan was liable for the assessed tax deficiency and fraud penalty.
2. Whether Gobins was liable as a transferee of Jelwan’s property under Section 311 of the Internal Revenue Code.
3. Whether Gobins could reduce her transferee liability by the amounts she spent on Jelwan’s behalf or returned to him.

Holding

1. Yes, because unexplained bank deposits and other evidence supported the determination of a tax deficiency resulting from fraud.
2. Yes, because Jelwan transferred property to Gobins in fraud of creditors and was insolvent as a result.
3. Yes, in part. Gobins could reduce her liability by the value of property returned to Jelwan prior to the notice of transferee liability, but not by the amounts spent on Jelwan’s behalf, as she failed to prove those debts had priority over the government’s tax claim.

Court’s Reasoning

The Tax Court held that the Commissioner’s determination of a tax deficiency was presumed correct, and unexplained bank deposits provided an adequate basis for the determination. The court found that Jelwan’s failure to report income and the existence of unexplained deposits supported the fraud penalty. Regarding transferee liability, the court found that the transfers from Jelwan to Gobins were made in fraud of creditors and rendered Jelwan insolvent, thus establishing a prima facie case of transferee liability. The court emphasized that under Section 1119, the Commissioner only needed to show transferee liability, not the underlying tax liability. While Gobins argued that she spent money on Jelwan’s behalf and returned some assets, she failed to show that the debts she paid for Jelwan had priority over the government’s tax claim. However, the court determined that the return of property to Jelwan before the notice of transferee liability purged the fraud to that extent, as it put Jelwan’s creditors in the same position they were in prior to the transfer.

Practical Implications

This case clarifies the burden of proof in transferee liability cases, placing the initial burden on the Commissioner to show a transfer in fraud of creditors that resulted in the transferor’s insolvency. It also demonstrates that a transferee can reduce their liability by returning fraudulently conveyed assets to the transferor before being notified of transferee liability. However, simply spending transferred funds on the transferor’s behalf does not automatically reduce transferee liability; the transferee must also demonstrate that those expenditures had priority over the government’s claim. This case also illustrates how the Cohan rule can be applied to estimate expenses when exact documentation is lacking.