Today, guest blogger Lavar Taylor continues his discussion of the interplay of the laws regarding third parties liable for a tax debt and the ability of those third parties to obtain CDP rights. If you have not had the chance to read his initial post on this topic, you might want to take time to read that one before digging into this one. These posts not only explore the ability of these third parties to obtain CDP rights but help anyone not familiar with the various ways that the IRS can seek payment of a taxpayer’s liability to gain a better understanding of the collection process. Keith
In Part 1 of this series of blog posts, I explained how the relevant statutes and regulations, together with the rationale of the Court deciding Pitts v. United States in favor of the IRS, support the conclusion that persons/entities who are alleged by the IRS to be the alter ego, successor in interest, and/or transferee of the party who incurred the tax liability (“original taxpayer”) are entitled to their own independent Collection Due Process (“CDP”) rights under §§ 6320 and 6330 of the Code. In the present blog post, I explain why I believe that the IRS is speaking out of both sides of its mouth when it denies alleged alter egos, successors in interest, and transferees their own independent CDP rights under §§ 6320 and 6330.
The IRS, in the current version of the Internal Revenue Manual (“IRM”), instructs revenue officers to treat partners in a general partnership which incurred unpaid federal taxes as “persons liable for the tax” for purposes of administratively enforcing the partnership’s unpaid tax liability. Per the IRM, these general partners are to be given CDP Lien and Levy notices under sections 6320 and 6330, in addition to the CDP Lien and Levy notices provided to the taxpayer partnership. Thus, IRM section 22.214.171.124.2(5)(08-05-2016), titled CDP Hearing Requests, provides in section (5) as follows:
If the tax liability involves a partnership, a request for a CDP hearing under IRC 6330 would cover all partners in the partnership. Under IRC 6320, the partnership and partners listed on the NFTL receive the CDP hearing notice. A partner with authority to represent the partnership could request a hearing for the partnership or a partner listed on the NFTL could request a CDP hearing as an individual partner.
Similarly, IRM 126.96.36.199.1.4(4) (03-29-2012), titled Determining Timeliness-Levy, provides that “[f]or partnerships, Collection may issue separate notices to individual partners as well as the partnership entity.” IRM Section 188.8.131.52 (03-29-2012), titled Partnership Liability, states as follows:
1. Under state law, general partners in partnerships are liable for taxes assessed against the partnership. In United States v. Galletti, 541 U.S. 114 (2004), the Supreme Court held the Service’s assessment against a partnership serves to make the general partner liable for the tax. While the Supreme Court did not address administrative collection, Galletti is consistent with the Service’s long-standing legal position that it can enforce a tax lien and take administrative levy action against a general partner based on the assessment and notice and demand directed to the partnership. See Chief Counsel Notice 2005-003 at http://www.irs.gov/pub/irs-ccdm/cc-2005-003.pdf .
2. A partner’s individual CDP hearing request:
— DOES NOT affect Collection’s ability to collect from the partnership or other individual partners’ assets
— DOES affect Collection’s ability to collect from that partner’s individual assets.
Chief Counsel Notice 2005-003 explains in detail the rationale for the IRS’s position that the IRS may pursue administrative collection action against general partners personally for taxes incurred by and assessed against the partnership itself. Essentially, the IRS takes the position that it may take advantage of state law to pursue collection of a tax liability against someone other the person who incurred the tax liability. That concept is not a new one – it is the bedrock of the Supreme Court’s decision in Commissioner v. Stern, 357 U.S. 39 (1958), which deals with the assertion of transferee liability under what is now section 6901 of the Code. In the case of a general partner of a general partnership, the IRS is using the relevant state’s version of the Uniform Partnership Act, which provides that general partners are personally liable for partnership debts.
Why is the IRS speaking out of both sides of its mouth when it grants partners in general partnerships their own CDP rights under §§ 6320 and 6330 with respect to taxes incurred by the partnership but denies those same CDP rights to alleged alter egos, successors in interest and transferees of the original taxpayer? Simply put, the IRS, in seeking to hold third parties liable as the alleged alter ego, successor in interest, and/or transferee of the original taxpayer, is invoking state law to hold a third party liable for the taxes of the original taxpayer.
Conceptually, there is no difference between the IRS invoking state law to hold a general partner of a general partnership liable for the partnership’s tax liability and the IRS invoking state law in an effort to hold someone other than the original taxpayer liable for that tax liability as an alleged alter ego, successor in interest, and/or transferee of the original taxpayer. While determining whether a person or entity is a partner of a general partnership is normally a simpler task than determining whether a person or entity is an alter ego, successor in interest, or transferee of the original taxpayer, both types of determinations involve the application of state law to a given set of facts to determine whether a third party can be held liable for taxes owed by the original taxpayer.
It is clear that state law governs the question of whether a third party can be held liable as an alter ego, successor in interest, and/or transferee of the original taxpayer for taxes assessed against the original taxpayer. See, e.g., Commissioner v. Stern, 357 U.S. 39 (1958) (transferee), Wolfe v. United States, 798 F.2d 1241, (9th Cir. 1986) (alter ego), TFT Galveston Portfolio, Ltd. v. Comm’r, 144 T.C. 96 (2015) (successor in interest), see also Fourth Inv. LP v. United States, 720 F.3d 1058 (9th Cir. 2013) (nominee). It seems to me that, if the IRS’s assertion of liability under state law to enforce a general partnership’s tax liability against a general partner of that partnership is sufficient to trigger CDP rights for the general partner, the IRS’s assertion of liability under state law to enforce a taxpayer’s tax liability against a third party as an alleged alter ego, successor in interest, or transferee should also be sufficient to trigger CDP rights for the alleged alter ego, successor in interest, or transferee.
In the Tax Court cases which we recently settled, the IRS argued that it was not being inconsistent in denying our client (which was an alleged alter ego/successor in interest of the original taxpayer) its own independent CDP rights while allowing those same rights to partners of general partnerships that incur tax liabilities. The IRS argued as follows:
The alter ego doctrine is used in federal tax cases to collect the liability of a taxpayer from a separate corporate entity that is operating to impair the government’s ability to satisfy the taxpayer’s legitimate tax liability. See Oxford Capital Corp. v. United States, 211 F.3d 280, 284 (5th Cir. 2000); Valley Fin. V. United States, 629 F.2d 162, 172 (D.C. Cir. 1980). Once respondent has determined that an entity is an alter ego, that entity’s assets may be levied upon for the debtor of the taxpayer because the law does not recognize the taxpayer and the alter ego entity as each having independent existence for purposes of debt collection. See Oxford Capital Corp., 211 F.3d at 284; see also United States v. Scherping, 187 F.3d 796, 801-02 (8th Cir, 1999).
There are two significant problems with the IRS’s argument (aside from the fact that the IRS’s argument fails to address successor in interest liability). First, there is both federal and California case law which makes clear that an entity is considered a valid, separate entity even when that entity is liable for a third party’s debt under the alter ego doctrine. In Wolfe v. United States, 798 F.2d 1241 (9th Cir. 1986), the Ninth Circuit upheld the application of the alter ego doctrine under Montana law against the shareholder of a corporate taxpayer. In doing so, the Ninth Circuit stated as follows:
Indeed, despite Wolfe’s contentions, it is not necessarily inconsistent to view a corporation as viable for the purpose of assessing a corporation tax, while disregarding it for the purpose of satisfying that assessment. Only those corporations that were established with no valid purpose are considered sham corporations, and thus not entitled to separate taxable status. See Moline Properties v. Commissioner, 319 U.S. 436, 439, 87 L. Ed. 1499, 63 S. Ct. 1132 (1943). A corporation could have a valid business purpose (giving it separate tax status), and at the same time be so dominated by its owner that it could be disregarded under the alter ego doctrine. Cf. National Carbide Corp. v. Commissioner, 336 U.S. 422, 431-434 & n. 13, 93 L. Ed. 779, 69 S. Ct. 726 (1949) (finding insignificant, for the purpose of determining whether a subsidiary corporation is entitled to separate taxable status, the fact that the owner retains direction of the subsidiary’s affairs, provides all of its assets, taxes all its profits, and exercises complete domination and control over its business). This view has been adopted by the Fifth Circuit. See Harris v. United States, 764 F.2d 1126, 1128 (5th Cir. 1985) whether or not [the corporation] was a separate taxable entity is not the same question as whether it was an alter ego for the purpose of piercing the corporate veil”).
Thus, Wolfe, and the cases cited in the Wolfe opinion, make clear that a corporation can be a valid, separate entity from the original taxpayer for purposes of the CDP procedures, even if the IRS is seeking to hold a corporation liable under the alter ego doctrine for the taxes owed by the original taxpayer.
Similarly, California law, upon which the IRS was relying in the now-settled cases we were handling in Tax Court, makes clear that a third party entity which is held liable as the “alter ego” of the original obligor remains a valid, independent entity for purposes of California law. In Mesler v. Bragg Management Co., 39 Cal. 3d 290 (1985), the California Supreme Court made this point very clear while holding that a parent corporation could be sued as the alleged alter ego of its subsidiary, even though the plaintiff had previously reached a settlement agreement with the subsidiary. The Court stated in relevant part as follows:
[W]hen a court disregards the corporate entity, it does not dissolve the corporation. “It is often said that the court will disregard the ‘fiction’ of the corporate entity, or will ‘pierce the corporate veil.’ Some writers have criticized this statement, contending that the corporate entity is not a fiction, and that the doctrine merely limits the exercise of the corporate privilege to prevent its abuse.” (6 Witkin, op. cit. supra, §5, at p. 4317; see, e.g., Comment, supra, 13 Cal. L.Rev. at p. 237.)
The essence of the alter ego doctrine is that justice be done. “What the formula comes down to, once shorn of verbiage about control, instrumentality, agency, and corporate entity, is that liability is imposed to reach an equitable result.” (Latty, Subsidiaries and Affiliated Corporations (1936) p. 191.) Thus the corporate form will be disregarded only in narrowly defined circumstances and only when the ends of justice so require.
It is not that a corporation will be held liable for the acts of another corporation because there is really only one corporation. Rather, it is that under certain circumstances a hole will be drilled in the wall of limited liability erected by the corporate form; for all purposes other than that for which the hole was drilled, the wall still stands. 39 Cal. 3d at 300-301.
To the extent that state law is relevant in this context, California law supports the conclusion that an alleged alter ego is a separate entity which is entitled to its own independent CPD rights. (For taxpayers located outside of California, and outside of the Ninth Circuit, the relevant case law will obviously be different.)
The second problem with the IRS’s argument is that the two cases which it cited both pre-date the CDP procedures, which took effect in January of 1999, following the enactment of RRA 1998 in July, 1998. The resolution of the question of whether an alleged alter ego, successor in interest, or transferee of the original taxpayer is entitled their own independent CDP rights will likely depend on the statutory interpretation of the CDP provisions, §§ 6320 and 6330. There are no cases which address this issue. And as is explained in Part 1 of this series of blog posts, the question of how to interpret §§ 6320 and 6330 is likely to be influenced by looking to §§ 6321 and 6331.
Notably, § 6331 refers to the need to provide a “notice and demand” before levy action may be pursued. This is a reference to “notice and demand” as set forth in IRC § 6303(a), which requires the IRS to provide “notice to each person liable for the unpaid tax, stating the amount and demanding payment thereof.” This notice must be sent to the person’s “last known address” within 60 days of the date on which the tax is assessed. Id. Failure to give a valid notice and demand renders void any levy action by the IRS and requires the IRS to refund all monies collected by levy. See Martinez v. United States, 669 F.2d 568 (9th Cir. 1981) (IRS was required to return all funds received by levy where IRS failed to give taxpayer a valid notice and demand under § 6303(a) prior to issuing levies). Failure to give a proper notice and demand also prevents the IRS from taking future administrative enforcement actions such as filing lien notices and issuing levies. See United States v. Coson, 286 F.2d 453 (9th Cir. 1963) (failure to send proper notice and demand to putative partner of a general partnership rendered tax lien void), United States v. Chila, 871 F.2d 1015 (11th Cir. 1989), cert. denied, 493 U.S. 975 (1989) (failure of the IRS to send a valid notice and demand to the taxpayer precludes the IRS from taking administrative collection action with respect to the unpaid taxes but does not prevent a suit to reduce the assessment to judgment), Blackston v. United States, 778 F.Supp. 244 (D. Md. 1991) (Marvin Garbis, J.).
There is a further requirement that the IRS send a notice of intent to levy under IRC § 6331(d) at least 30 days before the IRS levies “upon the salary or wages or property of any person with respect to any unpaid tax.” This requirement, largely forgotten since the enactment of section 6330, has never been repealed. Its primary significance now is that the sending of this notice triggers an increase in the accrual rate of the failure to pay penalty under IRC §§ 6651(a)(2) and (a) (3). See IRC § 6651(d)(1).
The language of §§ 6303(a) and 6331(d) is similar to the language used in §§ 6320 and 6330. Yet we know that the IRS does not send a “notice and demand” for payment under § 6303(a) within 60 days of the date of assessment to alleged alter egos, successors in interest, or transferees who have not been separately assessed that tax liability. Similarly, we know that the IRS does not send § 6331(d) notices to alleged alter egos, successors in interest, or transferees prior to issuing levies against the property of alleged alter egos, successors in interest, or transferees. How is it that the IRS is able to take administrative collection action against alleged alter egos, successors in interest, and/or transferees without complying with §§ 6303(a) and 6331(d)?
The answer to that apparent conundrum may surprise you. While it is possible to argue that the IRS may take administrative collection action against alleged alter egos, successors in interest, and/or transferees who have not been separately assessed a tax liability without complying with the requirements of §§ 6303(a) and 6331(d), it is far from clear that this argument carries the day. There are other arguments, some of which, in my view, have not been properly articulated in recent years. Perhaps Pitts was incorrectly decided, and the IRS is not entitled to take administrative collection action against alleged alter egos, successors in interest, or transferees at all. That topic will be explored in greater detail in Part 3 of this series.