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In its 2003-2004 term, the U.S. Supreme Court will consider whether the Internal Revenue Service may collect partnership tax liabilities against a partnership’s general partners without first making an assessment for the partnership’s tax obligations against the general partners. United States v. Galletti will have significant implications as to the IRS’s ability to collect tax obligations, and, if allowed, subject consumer debtors to additional liabilities for which the inclusion of those partnership liabilities may render consumer debtors ineligible for Chapter 13 relief. U.S. Bankruptcy Judge Ernest M. Robles of the Central District of California heard the case and issued an unreported opinion in the year 2000, from which the following facts are taken: The Gallettis, along with another couple, were general partners in a California partnership. The partnership incurred employment tax obligations for 1992-1995 by failing to remit payroll tax obligations to the IRS. In October 1999, the Gallettis (the debtors) filed for Chapter 13 bankruptcy protection. The IRS filed a proof of claim in the Gallettis’ Chapter 13 case; that proof of claim included the unpaid employment taxes for the Gallettis’ partnership. The bankruptcy court went on to note that the IRS’s proof of claim identified the employment tax liabilities by the partnership’s tax identification number and not by the individual general partners’ Social Security numbers. The debtors objected to the IRS’s proof of claim, alleging that although they were liable for the partnership’s obligations pursuant to California partnership law, the IRS could not collect the partnership’s tax obligations against them without first making an assessment of the tax against the general partners. Also, because the IRS had not made a proper assessment against the general partners, the Gallettis argued that the statute of limitations in which to collect the partnership’s tax obligations against them had expired. The IRS argued to the bankruptcy court that a separate assessment was unnecessary because the Internal Revenue Code (IRC) does not require a separate assessment if the assessment of the tax is proper against the partnership. Further, the IRS maintained that IRC �6203, which requires the IRS to provide the taxpayer with an assessment, is inapplicable to general partners because the term “taxpayer” under the IRC does not include general partners. Finally, the IRS noted that because the partnership was properly assessed its tax liabilities within three years of the date(s) in which the returns were filed by the partnership, the debtors’ statute of limitations argument was moot because there had been a timely assessment of the tax. Robles noted that there was no dispute that the debtors were liable for the partnership’s debt under the California Corporation Code. That said, he equated assessment of the tax for purposes of collection with that of taking a judgment against the general partners for the partnership liability before collection could occur. The bankruptcy court found that for a “person” to be liable for a tax, there must first be a proper assessment of the tax. The bankruptcy court reasoned that IRC �7701(a)(14)’s use of the word “taxpayer” to include “any person subject to any internal revenue tax” and IRC �7701(a)(1)’s definition of “person” to include partnership meant that the IRC’s definition of “person” included a general partner. As such, for a taxpayer (read “general partner “) to be liable for any internal revenue tax, the IRS must make an assessment of the tax. Further, because the IRS’s certificate of assessment against the partnership did not include or identify the general partners, the general partners were not properly assessed the tax by the IRS, and, as such, the IRS could not collect the partnership tax liabilities against the Gallettis. Moreover, because IRC �6501(a) requires that a tax be assessed or a suit filed within three years of the date the return is due to allow the IRS to collect the tax, the statute of limitations had expired. On appeal to the U.S. District Court for the Central District of California, Judge Virginia A. Phillips recognized that the IRC definitions for “taxpayer” and “person” do not include “partner” or “general partner.” The court observed in its 2001 opinion, however, that the bankruptcy court did find that a general partner may be an “individual” subject to taxation, thereby triggering the requirement that the individual be assessed the tax liability before it can be collected by the IRS. Moreover, the district court noted that bankruptcy, other district courts and circuit courts have uniformly held that a valid assessment is a prerequisite to tax collection. Noting this predicate of proper assessment as a prerequisite to collection, the district court affirmed the bankruptcy court. Undeterred, the IRS appealed to the 9th U.S. Circuit Court of Appeals. In a reported opinion issued in 2002, the 9th Circuit adopted the reasoning of the lower courts, finding that assessment of tax liability against a partnership, without more, does not allow the IRS to collect the taxes directly from the individual partners. The 9th Circuit found under California law that for a creditor to collect from a general partner a debt of the partnership owed to a creditor, the creditor must first obtain a judgment against the individual partner before a court could hold the partner liable for partnership debt. The court further held that although each individual partner is liable for the debts of the partnership, a claim against the partnership does not give rise to a right of collection against the partnership. Therefore, because the IRS did not obtain a judgment (assessment) against the individual partners, the IRS had no right to assert a claim in bankruptcy for the debt. Far-Reaching Effects On June 23, 2003, the Supreme Court granted certiorari in Galletti. The IRS argues in its brief that the partners’ individual liability is derivative of the partnership liability. The IRS asserts that the IRC does not require a separate assessment of partnership tax liability against the individual partners for the partners to be liable. In fact, the IRS characterizes the assessment of the tax as essentially a bookkeeping notation. Moreover, the IRS posits that it is the “tax” and not the “taxpayer” that is assessed. Further, because the partnership was properly assessed by the IRS, thereby extending the statute of limitations for collection to 10 years, the liabilities listed on the IRS’s proof of claim were not time-barred. Finally, the IRS argues that the basis for filing of a claim in bankruptcy does not take a pre-existing judgment, but only a right to payment as defined under 11 U.S.C. �101(5)(a). In response, in their brief to the U.S. Supreme Court, the respondent-debtors note that the IRS could have easily made the individual assessments against the general partners by looking at the K-1s (an attachment that is submitted along with partnership tax returns when they are filed). As such, any difficulty that the IRS suggests in making the individual general partner assessment is easily discounted by the availability of information. The respondents also note that the IRS’s use of the term “derivative” to describe the individual partners’ liability for partnership debt conflicts with the IRC’s recognition that parties that are secondarily liable under the IRC are not defined as “taxpayers,” as defined by Congress. Therefore, normal IRS collection procedures would not apply to persons who are not “taxpayers.” Additionally, the respondents note that the failure to make an assessment as a prerequisite to collect a tax runs afoul of the Constitution’s due process clause requiring proper notice before an action can be taken against a person and his or her property. It seems that the IRS may have a difficult time persuading the Supreme Court that all three lower courts were wrong. At each step of the trial and appellate process, the bankruptcy, district and appellate courts have steadfastly held to the rule that an individual assessment is required under the IRC before collection can ensue. Conversely, should the IRS prevail, the repercussions would be far reaching. Because employment taxes are by definition nondischargeable and entitled to priority status under the U.S. Bankruptcy Code, partnership debts, if allowed against an individual partner, could render a plan infeasible because the debtor(s) would have to pay the debt off over the life of the Chapter 13 plan. Further, the imposition of the partnership tax liabilities in consumer cases could render the individual partners’ cases ineligible under �109(e) because the amount of the debt would exceed the eligibility limits of Chapter 13. Craig A. Gargotta has been an assistant U.S. attorney for the Western District of Texas for 13 years, practicing almost exclusively in bankruptcy law. He serves as editor-in-chief of The Federal Lawyer and as contributing editor of the American Bankruptcy Institute Journal. The views expressed in this article are the author’s and not those of the Department of Justice or the Internal Revenue Service.

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