On October 5, 2021, the Tax Court issued a Memorandum Opinion in the case of Dodd v. Commissioner (T.C. Memo. 2021-118). The primary issue presented in Dodd v. Commissioner were whether the petitioner was liable for the unpaid tax related to unreported IRC § 1231 gain
Holding: Indeed she was.
Background to Dodd v. Commissioner
During 2013, the petitioner in Dodd v. Commissioner was employed as the office manager of a law firm in Washington, D.C. During 2013, and continuing at least until 2020, the petitioner was also a member of Cadillac Investment Partners, LLC (Cadillac). The petitioner was the managing member of Cadillac and held a 33.5% share of its profit, loss, and capital account.
As managing member, the petitioner regularly signed agreements, tax returns, and other documents on Cadillac’s behalf. The managing partner of the firm, for which the petitioner worked, held the remaining 66.5% interest in Cadillac’s profit, loss, and capital account. The real estate assets owned by Cadillac included the building the firm was located.
During 2013, Cadillac sold commercial real property for $4 million, generating a net IRC § 1231 gain of $3,203,916, reporting such gain on a Form 1065 (U.S. Return of Partnership Income), which the petitioner signed as Cadillac’s managing member. Cadillac also reported ordinary business income of $5,700, a net rental real estate loss of $300,717, and distributions to partners of $614,882. Cadillac issued a Schedule K-1 (Partner’s Share of Income, Deductions, Credits, etc.) to the petitioner. This schedule showed that the petitioner held a 33.5% share of the partnership’s profit, loss, and capital.
The petitioner timely filed a 2013 return, which was prepared by the same certified public accountant that prepared Cadillac’s return. The petitioner reported wages of $116,479 from B&M and the items of income and loss that Cadillac had reported to her on the Schedule K-1. She included with her return Form 4797 (Sales of Business Property), reporting net IRC § 1231 gain of $1,073,312. Further, the petitioner reported a tax liability of $183,976, withholding credits of $14,245, and “amount you owe” as $169,882.
The trouble with the petitioner’s 2013 return was that she didn’t, technically, include “payment” with her return.
Taking great umbrage, the IRS assessed the tax shown as due, an addition to tax for failure to pay, and interest, and the petitioner did not “pay” the liability on notice and demand.
The Notice to Seize the Petitioner’s State Tax Refund
In September 2016, the IRS issued a Notice CP92 (Seizure of Your State Tax Refund and Your Right to a Hearing) to the petitioner, who timely requested a CDP hearing, challenging her underlying liability and stating that she could not pay the tax. Further, the petitioner alleged that she had never actually received the $1,073,312 reported on her return, asserting that the sale proceeds were used to pay off a line of credit of the law. She stated that she had reported this gain “in error” and expressed her desire to resolve the matter at the CDP hearing.
The hearing was held, but the SO was a bit of a dick. During the conference the SO told petitioner that no collection alternatives could be considered because she had supplied no financial information.
Point, IRS.
However, the SO did not offer any additional time to supply this information and did not address her challenge to her underlying liability.
Advantage, petitioner.
Three days later the IRS issued the petitioner a notice of determination sustaining the collection action, in which the Tax Court observed that Appeals “assert[ed] incorrectly” that the petitioner failed to “raise a challenge to the existence or amount of the underlying liability.”
Game, IRS.
The petitioner filed a timely petition to the Tax Court, who remanded the case to Appeals, which realized (read: was smacked in the face with) the error of its ways and allowed the petitioner to challenge her underlying liability.
On remand, the case was once again assigned to the SO Dick, who had conducted the petitioner’s original hearing. SO Dick sent a letter scheduling a telephone conference to the petitioner. That letter consisted of three pages of single-spaced text and closely resembled the letter scheduling the original hearing.
However, this new letter included an additional bullet point stating that the petitioner’s liability was determined based on the documents the petitioner submitted and the return that was filed. The petitioner failed to submit an amended return within three weeks as SO Dick had directed, and SO Dick accordingly informed the petitioner that the collection action would be sustained. SO Dick immediately closed the case and issued the petitioner a supplemental notice of determination.
(Just a reminder to our dear readers, this isn’t the first time we’ve written about SO Dick and his dickish IRS brethren. Here’s a PSA for all IRS (and public servants in general): When thinking about what you are going to do today, put “Don’t be a dick” at the top of your list.)
The case was returned to the Tax Court for further proceedings. In February 2019, the IRS filed a motion for summary judgment, urging that the petitioner was precluded from challenging her underlying tax liability because she failed to submit an amended 2013 return by SO Dick’s deadline. The Tax Court denied that motion, concluding that SO Dick had acted unreasonably by failing to take the steps necessary to get to the bottom of the petitioner’s underlying liability challenge.
Moving on from SO Dick
In October 2019, a new settlement officer was assigned to petitioner’s case, who confirmed that the petitioner’s tax for 2013 was properly assessed and that all other requirements of law and administrative procedure were satisfied.
Appeals offered the petitioner an installment agreement. During a March 2020, telephone call to discuss that offer, the petitioner requested additional time to investigate whether the law firm would take responsibility for this liability. Appeals granted her request, but the petitioner did not respond to follow-up phone calls or return an executed Form 433-D, Installment Agreement…for months.
In July 2020, the IRS issued petitioner a supplemental notice of determination sustaining the collection action, which notice rejected the petitioner’s underlying liability challenge, concluding that she had “constructively received the proceeds from [Cadillac’s] sale of the properties” and that she was taxable on her 33.5% distributive share of the partnership’s gain. Analysis of the petitioner’s financial information showed that she had “the ability to pay the balance in full,” and because the petitioner declined to execute Form 433-D, she was ineligible for a collection alternative.
Underlying Liability
A taxpayer may challenge the existence or amount of her underlying liability in a CDP proceeding only “if the person did not receive any statutory notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute” it. IRC § 6330(c)(2)(B). The IRS conceded that the petitioner was entitled to challenge at the CDP hearing her underlying liability for 2013, because the liability was self-reported on her return, and she had no prior opportunity to dispute it. See id.; Montgomery v. Commissioner, 122 T.C. 1, 8-9 (2004).
IRC § 702(a) provides that, “in determining his income tax, each partner shall take into account separately his distributive share” of the partnership’s items of income and loss. As particularly relevant here, each partner must include his or her distributive share of the partnership’s “gains and losses from sales or exchanges of property described in IRC § 1231.” IRC § 702(a)(3). Each partner’s distributive share is “determined by the partnership agreement.” IRC § 704(a).
IRC § 702(a) explicitly provides that each partner is taxable on “his distributive share” of partnership income. This rule applies regardless of whether the partner receives the income currently, via distribution or otherwise. See United States v. Basye, 410 U.S. 441, 454 (1973) (holding that “no matter the reason for nondistribution each partner must pay taxes on his distributive share”); Eaton Corp. & Subs. v. Commissioner, 152 T.C. 43, 53 (2019) (holding that “each partner is taxed on its distributive share of partnership income without regard to whether the income is actually distributed”).
Holding in Dodd v. Commissioner
Although the petitioner asserted that Cadillac’s sale proceeds went directly to the bank to pay for someone else’s responsibility and that she “never received the money directly or indirectly,” Appeals found that a portion of the proceeds was used to repay Cadillac’s debt to the bank. As such, the petitioner benefited from that repayment because her share of Cadillac’s liabilities was reduced.
For Federal tax purposes, the Tax Court observed that the question is not whether the petitioner benefited from these loan repayments or “constructively received” the funds, Treas. Reg. § 1.451-2, rather, under IRC § 702(a), the petitioner was taxable on her distributive share of the IRC § 1231 gain—whether or not it was distributed.
Consequently, the Tax Court held that the petitioner was required to include her distributive share of Cadillac’s net IRC § 1231 gain in in her 2013 gross income.
Game, set, match – IRS.
(T.C. Memo. 2021-118) Dodd v. Commissioner
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