IRS Collection From Business Partner’s Property – Houston Tax Attorneys

Many business owners choose to acquire and operate their businesses with partners. This allows them to divide the responsibilities and share the risks and the rewards.

But what happens when one business partner falls behind on their federal taxes? Could the tax-compliant partner’s share of the business and business assets be at risk? Can the IRS seize and sell the tax-compliant partner’s assets? Can the IRS do this even if it effectively terminates the business?

The IRS has broad collection powers when it comes to delinquent taxes. Few realize that these powers can extend beyond the delinquent taxpayer to innocent third parties who own property jointly with the taxpayer, such as a business partner. While the law provides a remedy for spouses who file jointly and own joint property, there is no such remedy for business partners who are not spouses.

The recent decision in United States v. Driscoll, Civil Action 18-11762 (RK) (RLS) (D.N.J. Jan. 6, 2025), provides an opportunity to consider what business owners need to know to protect themselves in this situation.

Facts & Procedural History

The case involved a dental practice in New Jersey that was operated by two dentists. The dental practice was operated as an LLC formed under state law. Each of the dentists owned a 50 percent interest in the dental practice. They also both owned a 50 percent interest in the office building in which the dental practice operated.

One of the dentists failed to pay federal income taxes for nearly a decade. He owed approximately $500,000 in back taxes. The IRS eventually filed tax liens against the taxpayer’s property interests and filed suit to force the sale of both the entire dental practice LLC and the entire office building.

The innocent business partner did not owe back taxes and had no tax liability. He opposed the forced sale. He argued that forcing him to sell his interests would require him to close his practice, lay off employees, and abandon his patient relationships. The business partner offered alternative solutions, such as allowing the IRS to sell only the taxpayer’s 50 percent interests or using a charging order against the taxpayer’s LLC interest.

The IRS rejected the partner’s proposals and asked the court to force the sale of the entire dental practice LLC and the entire interest in the real estate.

The Authority to Force Property Sales

The IRS’s power to collect delinquent taxes starts with Section 6321 of the tax code. This law allows the IRS to place a lien on “all property and rights to property” belonging to a delinquent taxpayer. This law has a very broad scope. It covers virtually any property interest the taxpayer owns, from real estate to business interests to financial accounts. The IRS lien can even reach certain trust assets, but maybe not if the trust is structured properly.

The filing of the IRS lien notice itself is not a high hurdle for the IRS. The lien notice is just a pre-printed form that is filed into the public records and mailed to the taxpayer’s last known address. The IRS files these in bulk with the various county clerks and secretary of state’s offices across the country. This is all that is required for the lien to be “filed.”

Once a lien notice has been filed, Section 7403 gives the IRS the authority to ask a court to force the sale of property to satisfy the unpaid tax debt. As relevant in this case, this authority extends beyond just the taxpayer’s interest. The court can order the sale of the entire property. This is true even when innocent third parties own portions of the property.

Notably, the statute uses the word “may” in describing the court’s powers. This opens the door for the courts to have some discretion in whether to order the foreclosure and sale of property.

The Rodgers Factor Analysis

Recognizing the potential harshness of forced sales on innocent co-owners, the Supreme Court established a factor test for the courts to consider in determining whether a forced sale is appropriate. These factors are set out in United States v. Rodgers, 461 U.S. 677 (1983) and have come to be known as the Rodgers factors.

The Rodgers factors say that the courts must consider four key factors in deciding whether to allow the IRS to foreclose on jointly-owned property:

Financial prejudice to the government if limited to selling only the taxpayer’s interest
Whether the innocent owner would expect their interest to be protected from a forced sale
Prejudice to the innocent owner, including practical and personal costs
The relative value and character of the liable and non-liable interests

In practice, courts tend to focus heavily on whether there’s a realistic market for selling just the taxpayer’s interest. If selling a partial interest would significantly reduce the sale price or make finding a buyer difficult, courts are more likely to order a complete sale.

In this case, the court found almost all of the factors in supported selling the entire dental practice LLC and the entire real estate in which it operated. The court reasoned that there was no market for buying a partial interest in these assets and, surprisingly, that there was no harm to the innocent taxpayer as he would receive payment for his interests.

Charging Order vs. Section 7403 Forced Sale

To understand this case, we also have to consider the difference between a charging order and the IRS’s Section 7403 forced sale power.

The innocent partner in this case argued that the proper remedy was a charging order. The reason why he did that was that a charging order is a more limited remedy that:

Only redirects distributions/profits from the LLC to the creditor
Leaves the LLC ownership structure intact
Does not give the creditor management rights
Is typically the exclusive remedy available to private creditors under state LLC laws
Preserves the business as a going concern

In contrast, Section 7403 allows the IRS to:

Force the sale of the entire business and property
Extinguish all ownership interests
Override state law limitations
Terminate the business entirely
Convert all interests to cash proceeds

So while a charging order just diverts profits, Section 7403 allows the IRS to completely liquidate the business–a much more severe remedy that reflects the IRS’s unique collection powers under federal law.

The court in this case directly addressed this distinction. It rejected the innocent partner’s argument that a charging order should be used. The court explained that while state law limits regular creditors to charging orders, the IRS’s power under Section 7403 “does not arise out of its privileges as an ordinary creditor, but out of the express terms of § 7403.”

Application of Favorable State Law

Given this outcome, you may be wondering whether simply choosing a different state to form the LLC may have produced a different result for the LLC interest.

While some states (like Nevada or Wyoming) have stronger charging order protections for LLCs, the court in in this case made clear that state law protections don’t bind the IRS when it’s pursuing collection under Section 7403. The court explicitly stated that “neither New Jersey law nor the IRS manual binds the Court in this case” and that while state law defines the underlying property interests, “the consequences that attach to those interests is a matter left to federal law.”

So while favorable LLC jurisdictions might provide protection against private creditors, they might not prevent the IRS from forcing a sale of the entire business under Section 7403 when pursuing a tax-delinquent partner.

Adding Protections in Legal Agreements

This does not mean that business partners are without options. Partners can take several steps to protect themselves when drafting their partnership agreements and maybe even in real estate deeds.

For partnership agreements, partners can include several protective provisions. First, they can require all partners to maintain tax compliance and provide periodic proof, such as tax transcripts or certificates of compliance from taxing authorities. Second, they can include buyout rights that give non-delinquent partners the first opportunity to purchase a tax-delinquent partner’s interest before the IRS pursues collection (whether the delinquent partner is dead or live at the time or going through a divorce). These provisions should clearly specify both the triggering events and the process for exercising the buyout rights. Third, the agreement can establish specific valuation methods for partnership interests, such as predetermined formulas or procedures for obtaining third-party valuations. Having these valuation methods in place helps avoid disputes and expedites any necessary buyouts.

For real estate deeds, the parties can include contingent interests that automatically revert ownership back to the non-delinquent partner upon specific trigger events, such as tax liens being filed against the property. The deed can specify that each owner’s interest is conditioned upon maintaining tax compliance, with a reversionary right in favor of the other owner if this condition is breached. There are court cases with varying fact patterns where taxpayers have prevailed over the IRS by changing the real estate filings. There are other cases where transfers failed. While the effectiveness of such provisions against the IRS is uncertain, they may provide additional leverage in negotiations or court proceedings.

These protections must be established before any tax problems arise. Attempting to add these protections after tax issues exist could be viewed as an improper attempt to avoid collection. The IRS even has tools available to it for this circumstance too, including its right to pursue the innocent partner using the transferee liability statutes and, in more egregious cases, even criminal penalties.

The Takeaway

Business owners should understand that their business partner’s tax problems can directly affect their own interests in joint property. This is true even if one partner has done nothing wrong. To protect against this the partners may consider including provisions in partnership agreements that require partners to maintain tax compliance, give other partners rights to buy out a delinquent partner’s interest, and establish valuation methods for partner buyouts. Business partners might also benefit from adding language to real estate deeds for this contingency.

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Stephan Dorsey

Stephan is the sports journalist for the Maple Grove Report.

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Tax Refunds Lost to Timing Rules: Lesson, File Early, Pay Late – Houston Tax Attorneys

You should always pay your taxes on time, right? After all, early payment avoids tax penalties and interest, and shows good faith compliance with tax obligations.

This is not always the best approach. Why? Taxpayers who pay early or even on time may be precluded from getting money back from the IRS if they overpaid their tax liability. In some cases, taxpayers who delay making payments to the IRS may have more refund rights than those who pay on time.

This issue typically arises in two scenarios where taxpayers make advance payments to the IRS. First, when taxpayers make payments but fail to file timely returns. Second, when taxpayers make payments and the IRS conducts an audit or makes an adjustment that results in a statutory notice of deficiency. In both cases, the taxpayer may later discover they not only don’t owe additional tax—they actually overpaid and are due a refund. This problem lies with payments made before either the late-filed tax return or the IRS’s notice of deficiency–which taxpayers may not be able to get back from the IRS. The recent Applegarth v. Commissioner, T.C. Memo. 2024-107, provides an opportunity to consider these timing issues.

Note: there are other rules that come into play for refunds in collection due process hearings, which are similar but different than when you have an IRS adjustment or notice of deficiency as we are addressing in this article.

Facts & Procedural History

The taxpayer in this case made estimated tax payments to the IRS for 2014 and 2015. The payments were all made on or before the extended due dates for the tax returns for 2014 and 2015.

The taxpayer then filed his 2014 return in June 2019 and never filed his 2015 return.

In November 2019, the IRS issued notices of deficiency to the taxpayer for both years. The taxpayer filed a petition with the U.S. Tax Court to challenge the IRS’s determinations.

The taxpayer provided an amended return to the IRS attorney during the tax litigation. The parties ultimately agreed that there were significant overpayments–$78,472 for 2014 and $9,603 for 2015. So not only did the taxpayer not owe the amounts asserted by the IRS in its notice, the taxpayer was actually owed money back from the IRS.

The question before the court was whether the U.S. Tax Court could order refunds of the overpayments given the statutory time limitations.

The Refund Claim Framework

This is probably not a surprise, but there are a number of deadlines set out in the tax code. For this case, there are two key provisions to consider, i.e., Section 6511(b)(2) and 6512(b)(3).

Section 6511(b)(2) establishes the “lookback” periods for refund claims. For taxpayers who file a tax return, they can recover payments made within three years plus any extension period before the refund claim. For taxpayers who don’t file a return, they can only recover payments made within two years of their refund claim.

Section 6512(b)(3) applies specifically to cases brought in the U.S. Tax Court. It limits the Tax Court’s ability to order refunds to: (1) payments made after the IRS issues its notice of deficiency, (2) payments that would be refundable if a refund claim had been filed on the notice date, or (3) payments covered by an actual refund claim filed before the notice date.

This creates a connection between the notice date and refund rights. Taken together, these code sections limit refund rights based on when payments were made relative to when refund claims are filed or deemed filed. This is why a taxpayer who files a petition with the U.S. Tax Court in response to a notice of deficiency has to focus on the date of the IRS’s notice of deficiency. The code treats this date as a hypothetical refund claim date and only allows recovery of payments made within specific “lookback” periods measured from this date. For taxpayers who haven’t filed returns, this lookback period is generally just two years before the date of the IRS notice. That is the issue in the Applegarth case.

In Applegarth, the taxpayer’s payments were all made more than two years before the November 2019 notice of deficiency. Because he hadn’t filed returns within the proper timeframe, the two-year lookback period applied. As a result, the U.S. Tax Court could not order refunds of the overpayments, even though everyone agreed that the taxpayer was otherwise entitled to the refunds.

Understanding the Lookback Periods

IIt is helpful to consider an example here. Imagine a taxpayer who paid $10,000 in taxes on April 15, 2020, but later discovers they only owed $5,000. Their ability to get back the $5,000 overpayment depends on when they take action.

If they file a tax return (which serves as a refund claim), they can recover payments made within 3 years plus any extension period before filing the refund claim. So if they file the tax return on April 15, 2023, they can get back the April 2020 payment. The 3-year lookback period protects their refund rights.

The situation is quite different if they never file a return and the IRS sends a notice of deficiency. In this case, they can only recover payments made within 2 years before the notice date. So if the IRS sends a notice on April 15, 2023, they can only get back payments made after April 15, 2021. Their April 2020 payment falls outside this 2-year window and is lost.

This is why the Applegarth case turned out the way it did. Since the taxpayer hadn’t filed returns within the proper timeframe, he was stuck with the shorter 2-year lookback period. His payments were made too early to fall within this window.

Planning Around the Timing Rules

These refund rules create some counterintuitive results. A taxpayer who files their return late but within three years of payment has more refund rights than a taxpayer who doesn’t file at all and waits for an IRS notice. And a taxpayer who pays at the last minute (but within two years of an IRS notice) may have more refund rights than one who paid years earlier.

This doesn’t mean taxpayers should delay payments to the IRS. Late payment penalties and interest usually outweigh any theoretical benefit from preserving refund rights. However, it does mean that taxpayers who have made payments should prioritize filing their returns, even if late. A late-filed return is far better than no return when it comes to preserving refund rights.

Given these concepts, there are a few issues that you may be thinking about. One is situations in which a taxpayer is required to file a return with an estimate, and has to true up the return later? There are situations like this built into our tax laws. We covered that topic here as to fixing estimates.

The other question is whether the taxpayer can argue that they did file a timely tax return, even though they technically did not. If the taxpayer has no other arguments, one argument might be that they did file a tax return as a refund claim, it was just an informal refund claim. There is some chance that something the taxpayer provided to the IRS could count as a refund claim–even if it was just a letter or other correspondence the taxpayer sent to the IRS.

Takeaway

The lesson from this case isn’t that taxpayers should delay paying their taxes. Rather, it highlights the critical importance of filing tax returns, even if they’re late. While timely tax payments are important, they must be paired with a filed return to preserve refund rights. Taxpayers who have made significant payments should file returns or protective claims if they discover potential overpayments. Otherwise, as Applegarth shows, the taxpayers could permanently lose their right to substantial refunds due to timing rules alone.