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ARE ALLEGED ALTER EGOS, SUCCESSORS IN INTEREST AND/OR TRANSFEREES ENTITLED TO THEIR OWN COLLECTION DUE PROCESS RIGHTS UNDER SECTIONS 6320 AND 6330? PART 3

Posted on June 5, 2018

We welcome back guest blogger A. Lavar Taylor who brings us his third article in a series on the rights of third parties to obtain a Collection Due Process hearing. As he usually does, Lavar goes back to basics and breaks down why the current rulings may have missed the mark as he broadens our understanding of the process and how the parts fit together. Keith

At the end of Part 2 of this series, I raised the question of whether In re Pitts, 515 B.R. 317 (C.D. Cal. 2014), aff’d, 688 F. App’x 774 (9th Cir. 2016) was decided correctly. The Pitts court held that the IRS may take administrative collection action against a general partner of a general partnership to collect employment taxes incurred by the partnership, without making a separate assessment against the general partner. The court held that the general partner is a “person liable for the tax” for purposes of section 6321 because the general partner is liable for the partnership’s employment taxes under California law. Notably, California law, like the laws of all other states, provides that a general partner of a general partnership is personally liable for all partnership debts.

The court in Pitts did not directly address the question of whether the general partner was entitled to their own independent Collection Due Process (“CDP”) rights under sections 6320 and 6330 of the Internal Revenue Code. Nevertheless, it follows from the holding in Pitts that a general partner is entitled to their own independent CDP rights under sections 6320 and 6330. As is discussed in Part 2, the Internal Revenue Manual (“IRM”) acknowledges that general partners in this situation are entitled to their own independent CDP rights.

Previously, I discussed why I believe that the IRS is talking out of both sides of their mouth in refusing to extend independent CDP rights under sections 6320 and 6330 to putative alter egos and successors in interest of taxpayers, while these rights are extended to partners of general partnerships. My argument is straightforward: if a partner who is personally liable under state law for a partnership’s unpaid tax liability is a “person liable for the tax” under sections 6320 and 6330, and thus is entitled to their own independent CDP rights, then an alter ego or successor in interest who is personally liable under state law for a third party’s unpaid tax liability is likewise a “person liable for the tax,” and thus, is entitled to their own independent CDP rights.

This post examines the question of whether Pitts, and cases such as the Ninth Circuit’s opinion in Wolfe v. United States, 798 F.2d 1241 (9th Cir. 1986), were decided correctly.  If Pitts and Wolfe were decided incorrectly, the rules governing the collection of unpaid taxes from third parties would be significantly different than they are today. Any time the IRS wanted to collect taxes from a putative alter ego of the taxpayer, a putative successor in interest of a taxpayer, or a partner of a taxpayer which is a general partnership, the IRS would have to refer the matter to the Department of Justice Tax Division to bring suit. Administrative collection action by the IRS against putative alter egos and successors in interest of the taxpayer (and against general partners of a partnership for taxes owed by the partnership) would be prohibited.

Before you summarily dismiss my suggestion that the IRS may be legally precluded from taking administrative collection action against putative alter egos and successors in interest as the product of a senile, stark raving mad tax controversy attorney who, after 37 years of practicing law in this area, has finally gone off of the deep end, read the rest of this post carefully. And as you carefully read through the rest of this post, consider the answer to following question:

Why was the predecessor to section 6901 of the Code enacted?

It is the answer to this question which supports the conclusion that the IRS may not take administrative collection action against putative alter egos or successors in interest of the original taxpayer in the absence of a separate assessment against the third party.

Why are the circumstances of the enactment of the predecessor to section 6901 so important to this analysis? The answer is quite simple. Before the enactment of the predecessor to section 6901, the government could not administratively pursue collection action against putative “transferees” of the persons who incurred the original tax liability, i.e., the “person liable for the tax.” Instead, the government was required to bring suit in federal or state court to prove that these third parties were personally liable as transferees.

This history is laid out in the Supreme Court’s opinion in Commissioner v. Stern, 357 U.S. 39 (1958), which construed section 311 of the Internal Revenue Code of 1939, the predecessor to section 6901. The Court stated at pages 42-43 as follows:

The courts have repeatedly recognized that § 311 neither creates nor defines a substantive liability, but provides merely a new procedure by which the Government may collect taxes. Phillips v. Commissioner, supra [referring to Phillips v. Commissioner, 283 U.S. 589 (1931]; Hatch v. Morosco Holding Co., 50 F.2d 138; Liquidators of Exchange National Bank v. United States, 65 F.2d 316; Harwood v. Eaton, 68 F.2d 12; Weil v. Commissioner, 91 F.2d 944; Tooley v. Commissioner, 121 F.2d 350. Prior to the enactment of §280 of the Revenue Act of 1926, 44 Stat. 9, 61, the predecessor of § 311, the rights of the Government as creditor, enforceable only by bringing a bill in equity or an action at law, depended upon state statutes or legal theories developed by the courts for the protection of private creditors, as in cases where the debtor had transferred his property to another. Phillips v. Commissioner, supra, at 283 U. S. 592, note 2; cf. Pierce v. United States, 255 U. S. 398; Hospes v. Northwestern Mfg. & Car Co., 48 Minn. 174, 50 N.W. 1117. This procedure proved unduly cumbersome, however, in comparison with the summary administrative remedy allowed against the taxpayer himself, Rev.Stat. § 3187, as amended by the Revenue Act of 1924, 43 Stat. 343. The predecessor section of § 311 was designed “to provide for the enforcement of such liability to the Government by the procedure provided in the act for the enforcement of tax deficiencies. S.Rep. No. 52, 69th Cong., 1st Sess. 30.

In Stern, the Court went on to hold that courts are required to look to state law for purposes of determining whether a party is a “transferee” who is liable for the tax incurred by the original “person liable for the tax.”

The purpose of section 6901, and of its predecessor first enacted in 1926, is clear: namely, to permit the IRS to impose personal liability on third party “transferees” and treat them as “persons liable for the tax” against whom the IRS may pursue administrative collection action, provided that the IRS follows the procedures set forth in section 6901. To comply with these procedures, the IRS must make a separate assessment against the transferee after issuing a section 6901 notice of deficiency to the alleged transferee, thereby allowing the alleged transferee to challenge the assertion of liability in Tax Court.

Thus, the predecessor of section 6901 first enacted in 1926 established a mechanism that resulted in third party transferees becoming “persons liable for the tax” against whom administrative collection action could be pursued. It would seem to follow from this analysis that, prior to the enactment of the initial predecessor of section 6901 in 1926, third party transferees were not “persons liable for the tax.” This conclusion is bolstered by looking at the predecessor to section 6303(a) of the Internal Revenue Code, which requires the IRS to send notice and demand for payment to “each person liable for the unpaid” tax within 60 days of the date on which the tax is assessed by the IRS.

The predecessor to IRC section 6303(a) that was in effect in 1926 when section 6901’s predecessor was enacted in 1926, Revised Statutes section 3184, provided in relevant part as follows:

Where it is not otherwise provided, the collector shall in person or by deputy, within ten days after receiving any list of taxes from the Commissioner of Internal Revenue, give notice to each person liable to pay any taxes stated therein, to be left at his dwelling or usual place of business, or to be sent by mail, stating the amount of such taxes and demanding payment thereof.

This language is remarkably similar to present-day section 6303(a), except that the current 60-day deadline to give notice and demand for payment was only 10 days. As is indicated in the legislative history of the predecessor to section 6901 cited above, at the time the predecessor to section 6901 was enacted, the IRS was not permitted to take administrative collection action against putative third-party transferees. Rather, the IRS was required to bring suit against putative third-party transferees in court. The fact that the IRS was not able to administratively pursue third party transferees under the predecessor to section 6303(a) at the time of the enactment of the predecessor to section 6901, a predecessor that reads remarkably like section 6303(a), supports the conclusion that the language in what is now section 6303(a) was never intended to authorize the issuance notice and demand for payment to any person other than the “taxpayer” who incurred the tax liability and against who an assessment has been made. It also supports the conclusion that putative transferees, alter egos and successors in interest were never intended to be within the scope of persons against which administrative collection action could be taken to collect the tax incurred by the “person liable for the tax.”

But what about cases such as Wolfe, discussed previously? Wolfe seemingly holds that the IRS may take administrative collection action against a shareholder of a corporation taxpayer based on the theory that, under state law, the shareholder is the alter ego of the corporation, without making a separate assessment against the shareholder and without sending the shareholder a separate section 6303(a) notice and demand for payment.

The short answer Is that the holding of Wolfe, which was decided before the enactment of the CDP procedures, not only misstates the law, but also has been undercut by the Supreme Court’s decision in United States v. Galletti, 541 U.S. 114 (2004). The relevant language from Wolfe is as follows:

Wolfe challenges the levy served upon him as illegal because no assessment was made against him as a taxpayer. He argues that levies to collect taxes can be served only upon taxpayers against whom assessments have been made. This argument is without merit.

Section 6331 of the Internal Revenue Code empowers the Government to collect overdue taxes by levying upon the taxpayer’s property. The regulations to this section provide that a levy can be served upon any person in possession of property subject to levy, by serving a notice of levy. 26 C.F.R. § 301.6331-1(a)(1) (1985). Thus, levies can be effected against any person in possession of the taxpayer’s property, not just against the taxpayer.

Wolfe misconstrues section 6331 by arguing that a notice of levy and a levy are distinct, and that a notice of levy, but not a levy, can be served on persons against whom assessments have not been made. Regulation 301.6331-1 makes clear that a notice of levy is simply a means of effecting a levy against persons in possession of taxpayer property.

Moreover, under alter ego theory, the assessment against the corporation was effective against Wolfe as well. See Harris, 764 F.2d at 1129 (under alter ego theory, assessment issued against corporation was effective as against both shareholder and corporation); see also Valley Finance, 629 F.2d at 169 (alter ego of corporation not entitled to separate notice of deficiency).

798 F.2d at 1245. The quote above omits footnote 5, which appears at the end of the quoted language. The contents of that footnote are critical to the Ninth Circuit’s holding and thus are quoted here in their entirety:

Wolfe’s reliance on United States v. Coson, 286 F.2d 453 (9th Cir. 1961), in support of his argument that the Government’s failure to file an assessment against him invalidated the levy is misplaced. Coson involved partnership tax liability, and since partners and partnerships, unlike corporations and shareholders, are not separate taxable entities, the case is distinguishable on that ground. The Coson court invalidated a levy against a partner because no assessment, notice or demand had been filed against him as a taxpayer. Here, on the other hand, the Government issued the required assessment, notice, and demand against the taxpayer corporation. Coson does not mandate that assessments be made against third parties in possession of taxpayer property before levies can be effected.

From this discussion, it is apparent that the Ninth Circuit did not understand that partnerships and their partners are distinct entities for purposes of tax administration. The fact that income from tax partnerships “flows through” to partners does not change the fact that a partnership is distinct from its partners for purposes of tax administration and does not mean that partners and partnerships “are not separate taxable entities.” Similarly, subchapter S corporations are distinct from its shareholders for purposes of tax administration, even though the income of a Subchapter S corporation flows through to its shareholders. Partnerships can incur their own tax liabilities, such as penalties for failure to file a partnership tax return, employment taxes and other excise taxes. In addition, the enactment of the new BBA partnership audit rules, which have now taken effect, make it very clear that partnerships and their partners are very distinct from one another for purposes of tax administration.

It appears that the Ninth Circuit in Wolfe refused to apply the rationale of Coson to the fact pattern in Wolfe because the Court believed that partnerships and their partners are the same entities for tax purposes in a collection context. Whatever logical force that this reasoning has (which is little or none), it appears that this reasoning was rejected by the Supreme Court when it decided in United Galletti that a partner of general partnership is not a “taxpayer” for purposes of assessing and collecting employment taxes incurred by the partnership.

The last sentence of footnote 5 in Wolfe is also problematical for those who seek to apply the holding in Wolfe to a situation where the government is attempting to impose personal liability against a third party as a putative alter ego of the “person liable for the tax.” That sentence suggests that the Court in Wolfe was dealing only with a situation where the IRS was merely seeking to levy on corporate property that was in the hands of the shareholder. If that was the situation, there would have be no need for the Ninth Circuit in Wolfe to discuss why the corporate shareholder was personally liable for the corporate taxes based on an alter ego theory.

Thus, there are a number of reasons why trial courts from which an appeal would lie to the Ninth Circuit are arguably free to disregard the Ninth Circuit’s holding in Wolfe and conclude that the IRS may not take administrative collection action against a putative alter ego of a or against a putative successor in interest of the person that incurred the tax liability.

Most of the cases in which our office has encountered an “alter ego” determination or a “successor in interest” determination by the IRS have involved employment taxes. The procedures set forth in section 6901 generally do not apply to employment taxes. They apply to the following types of taxes: (a) income taxes imposes by subtitle A; (b) estate taxes imposed by chapter 11; (c) gift taxes imposed by chapter 12; and (d) fiduciary liability under 31 USC 3713. See § 6901(a)(1).   Section 6901 procedures only apply to other types of taxes (such as employment taxes) only if the taxes in question “[arise] on the liquidation of a partnership or corporation, or on a reorganization with the meaning of section 368(a).” See § 6901(a)(2). This language effectively precludes the application of section 6901 to unpaid employment taxes.

While I have not searched for any authorities which discuss this point, there may have been historical reasons for Congress’ failure to include employment taxes within the scope of what is now section 6901. In 1926, the world was a different place. Income tax withholding from wages did not become universal until 1943. Social Security laws were not enacted until 1935, and a major expansion of those laws was not enacted until 1939, effective in 1940. Thus, in 1926, when the predecessor to section 6901 was first enacted, employment taxes and universal income tax withholding were not even in existence. In 1939, when the 1939 Code was enacted, employment taxes were very new, and there was no universal income tax withholding.

If, as the IRS contends, the IRS is free today to unilaterally assert personal liability under state law against third parties by taking administrative collection action against those third parties, without a separate assessment against the third parties and without bringing suit against the third parties in court, then it would appear that the enactment of the original predecessor to section 6901 back in 1926 was unnecessary. The same rationale which arguably permits the IRS to unilaterally pursue administrative collection action against putative alter egos and putative successors in interest today, without a separate assessment and without first going to court, arguably would have permitted the IRS to pursue administrative collection action against putative transferees back in 1926, without a separate assessment and without going to court, when the first predecessor to section 6901 was enacted.

Yet, back in 1926, it was clear that the IRS could not unilaterally pursue administrative collection action against putative transferees. The IRS was required to file suit in court. The question, then, is why should putative alter egos and putative successors in interest be in a worse position today from a standpoint of tax procedure and administration than putative transferees were in back in 1926? Other than the taxpayer friendly addition of the CDP provisions, the basic laws have not changed that much. Most, if not all, changes in the law have been “taxpayer friendly.”

The extent to which courts will have the intestinal fortitude to address in published opinions the question of why today’s putative alter egos and successors in interest should not be in any worse a position that the putative transferees were in 1926 prior to enactment of the predecessor to section 6901 remains to be seen. In Pitts, our office raised this issue in an amicus brief filed with the Ninth Circuit. The Ninth Circuit panel, cowards that they were, issued an unpublished opinion in which the Court did not address this issue.

Still, this issue is worth raising in any case in which a putative alter ego or putative successor in interest is also arguing that they are entitled to their own CDP rights. Court that are reluctant to declare that case law such as Wolfe is no longer good law may be more receptive to the argument that, to the extent the IRS is seeking to hold third parties personally liable for taxes incurred by another person, the IRS is required to give those third parties their own independent CDP rights.

In Part 4, I will address, among other issues, the issue of how putative alter egos and putative successors in interest might go about getting the Tax Court to rule on the issues discussed in Parts 1 through 3. There are a number of potential roadblocks to having these types of cases heard in the Tax Court, and care needs to be taken to avoid creating more potential obstacles than the ones that already exist. Getting into District Court is relatively easy. Part 4 will discuss both options and will discuss why putative alter egos and successors in interest might want to litigate these issues in the Tax Court, as opposed to the District Court.

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