Tax Court Corner: Lesson in Payroll Tax Complianceby
Although technically not a US Tax Court case, I give you the case of Pitts v. United States. It deals with a very important tax situation and is also a lesson in payroll taxes.
Wendy K. Pitts, a California resident, was a general partner of DIR Waterproofing, a California general partnership. To refresh your memory from college, in a general partnership there is no legal separation from the business to the general partner. This is the reason that most partnerships form limited liability companies or limited partnerships.
Pitts filed for Chapter 7 bankruptcy in 2012. Chapter 7 involves a liquidation proceeding in which the debtor’s nonexempt assets, if any, are sold by the Chapter 7 trustee, and the proceeds are distributed to creditors according to the priorities established in the US Bankruptcy Code.
For those of you who do tax resolution work, you will remember that the federal government is listed as one of the first priorities in the “firing order” of who gets paid under a Chapter 7 distribution. DIR Waterproofing didn’t pay its payroll taxes, and with penalties and interest, the partnership owed $110,000. DIR Waterproofing went out of business in 2008, so Notices of Federal Tax Lien were issued by the IRS to the partnership and Pitts as general partner.
On May 31, 2012, Pitts filed an adversary proceeding against the government in the bankruptcy court to discharge the federal tax liens – specifically to determine:
- The dischargeability of debts.
- The nature, extent, and validity of liens.
- Whether the IRS violated the discharge injunction under applicable bankruptcy provisions by failing to extinguish its liens on her personal property.
Now, anyone who does resolution will tell you that you can discharge debts for federal income taxes in Chapter 7 bankruptcy only if all of the following conditions are true: The taxes are income taxes, and taxes other than income (such as payroll taxes or fraud penalties) can never be eliminated in bankruptcy.
Pitts’ argument entailed, among other things, that her liability for DIR’s tax debt was solely as a partner and, as such, is not considered a “tax debt” under 11 USC Section 508(a)(8)(A) and should be dischargeable. The bankruptcy court sided with the government and indicated in its opinion that the government’s federal tax liens against her property were valid and perfected, and the IRS did not violate the discharge injunction.
Again, anyone who does tax resolution will tell you that Internal Revenue Code Section 6672 states: “Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over. No penalty shall be imposed under section 6653 or part II of subchapter A of chapter 68 for any offense to which this section is applicable.”
Pitts appealed. She argued, among other things, that a general partner is not a “taxpayer” with respect to payroll tax-withholding liabilities of her general partnership under Code Section 3403, and that the IRS failed to separately assess the tax against her under Section 6672 within the applicable three-year statute of limitations. She also claimed that because the IRS never assessed her tax liability, she wasn’t responsible for DIR’s tax debt under federal law. The district court rejected these arguments and affirmed the bankruptcy court’s decision.
Pitts then appealed to the US Court of Appeals for the 9th Circuit, stating that because she was a general partner liable for DIR’s debts under state law, the government is confined to the remedies held by state law; therefore, the government can’t use federal administrative enforcement procedures against her.
You have to hand it to Pitts’ attorneys. They really tried every angle here.
So, we all know how this ends. The 9th Circuit disagreed with Pitts, noting that under “plain language” of Section 6321, she is a “person liable to pay any tax” because she is the general partner. The court stated several cases that basically demonstrated where the IRS relied on state law to establish an individual’s liability; the government’s underlying right to collect money nonetheless derives from the operation of federal law.
The question may arise to you why a case regarding tax law is not being heard in Tax Court. Well, the only way for a case to get to Tax Court is to file a petition. You can only file a petition if you have been issued a notice of deficiency or you have gone to appeals and disagree with the appeals officer.
No matter how you look at this case, Pitts is personally liable for the taxes: either jointly as the general partner or under the trust fund.
Craig W. Smalley, EA is the CEO and Founder of CWSEAPA®, PLLC, located in Orlando, Florida, with clients all over the country in every industry. He has been admitted to practice before the IRS as an Enrolled Agent, and has a Master's Certificate in Taxation from UCLA. He has been in practice since 1994, specializing in individual, partnership...