Tax
Aug. 13, 2002
Circuit Warns IRS About Improper Bills In Partnerships
SAN FRANCISCO - The Internal Revenue Service practice of going after individual partners to collect the unpaid taxes assessed against their general partnership won't fly any longer.
In a significant victory for small businesses, a federal appeals court has ruled that the IRS cannot collect from individual partners the unpaid tax assessed only against the general partnership unless it first assesses, or bills, the individual members separately.
The 9th U.S. Circuit Court of Appeals decision Thursday was closely watched by tax lawyers and is likely to create a flurry of contentions that the ruling bars collection of taxes against many individuals whose partnerships faced unpaid tax claims. In re Galletti, 2002 DJDAR 9011.
"This is a really big deal," said tax attorney Mark R. Campbell, of Haberbush & Campbell in Long Beach, who represented the partners in Galletti. The IRS has gotten out of the practice of assessing individuals for taxes owed by the partnership, he said.
"It is hard to know how many people this will affect, but I have gotten calls from a number of lawyers saying it is affecting [their clients] right now," he said.
"The IRS was getting pretty cocky about it," he said, telling its agents in tax advisories not to worry about an earlier, identical ruling by a bankruptcy judge because it would be overturned by the 9th Circuit.
Normally, each member of a general partnership is jointly and severally liable for the taxes of the partnership. That is what the IRS has relied on for a number of years in assessing unpaid partnership taxes.
But for the first time in this circuit, the appeals panel said that was no longer permissible: "We hold that the assessment of tax liability against the partnership, without more, does not allow the IRS to collect those taxes directly from the individual partners."
In Galletti, the four partners in Marina Cabrillo Partners, created to build and run a hotel in San Pedro, failed to pay employment taxes between 1992 and 1995, according to the court. They filed for bankruptcy in 1999.
The IRS assessed the partnership for $395,000 in unpaid Social Security and unemployment taxes for 1994, 1995 and 1996. The IRS never filed individual tax assessments against the four partners before the three-year deadline for sending a tax bill. Instead, the IRS tried to get the bankruptcy court to order the individual partners to pay for the partnership's tax debt.
"The IRS' failure to assess tax deficiencies against debtors within the three-year period provided [in the Tax Code] bars it from collection of the unpaid debts of the partnership directly from debtors," Judge Susan Graber wrote. She was joined by Judge Andrew Kleinfeld and visiting Judge Susan Bolton of Arizona.
Attorney David Haberbush, who also represented the partners, said, "This opens up a whole new area of issues" for lawyers to consider."
"Prior to this, if you got a partnership tax bill, it was assumed they were good, even if there was no personal tax assessment made. Now you should check to see if an assessment occurred against an individual," he said.
And there could be plenty of cases pending, going back a number of years. "It has not been a practice of the IRS to [assess individuals], so there may be a number of cases," Haberbush said.
Bruce Friedland, an IRS spokesman in Washington, D.C. refused to discuss the case or the extent of the problem the ruling might create. "We don't discuss matters in litigation," he said.
Graber rejected the IRS' argument that because it had made a timely tax assessment against the partnership, giving it 10 years to collect, it could collect from the individuals.
She held that the partnership is one taxpayer, and the individual is another taxpayer, and each must be billed separately.
The court also rejected the notion that California state law of joint and several liability for general partners helped the IRS.
California does not allow a creditor to automatically collect from a general partner a debt that the partnership owes to the creditor.
"To the contrary, the creditor must first obtain a judgment against the partner, holding the partner liable for the partnership's debt," she wrote.
The IRS' argument "overreaches under state law," Graber wrote.
General partnerships are generally formed by small and mid-sized businesses that don't want to incorporate or create more complex structures.
The rules are not the same for limited liability partnerships, which are widely used by law firm partnerships, according to Campbell.
Pamela Mac Lean
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