X-twitter Facebook-f Pinterest-p
X-twitter Facebook-f Pinterest-p

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:

  1. Financial prejudice to the government if limited to selling only the taxpayer’s interest
  2. Whether the innocent owner would expect their interest to be protected from a forced sale
  3. Prejudice to the innocent owner, including practical and personal costs
  4. 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

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 prob…

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.

Watch Our Free On-Demand Webinar

In 40 minutes, we’ll teach you how to survive an IRS audit.

We’ll explain how the IRS conducts audits and how to manage and close the audit.  



Source link

Leave a Reply

Subscribe to Our Newsletter

Get our latest articles delivered straight to your inbox. No spam, we promise.

Taylor Swift and Travis Kelce Have Fans Convinced They’re Dog Parents

IRS Levy for a Debt It Already Agreed to Payment Over Time? – Houston Tax Attorneys

Risk Redux — Conflicts of the Father…, More on Judicial Recusal Reasons, Another Law Firm Data Breach

Married Filing Separate, Community Property Reduction – Houston Tax Attorneys

Conduct During IRS Audit Evidence of Tax Return Fraud – Houston Tax Attorneys

IRS Levy for a Debt It Already Agreed to Payment Over Time? – Houston Tax Attorneys

Risk Redux — Conflicts of the Father…, More on Judicial Recusal Reasons, Another Law Firm Data Breach

Married Filing Separate, Community Property Reduction – Houston Tax Attorneys

Google tries to ease concerns over NE Minn. data center

IRS Levy for a Debt It Already Agreed to Payment Over Time? – Houston Tax Attorneys

Risk Redux — Conflicts of the Father…, More on Judicial Recusal Reasons, Another Law Firm Data Breach

Married Filing Separate, Community Property Reduction – Houston Tax Attorneys

Recent Reviews

Conduct During IRS Audit Evidence of Tax Return Fraud – Houston Tax Attorneys


The courts have taken an expansive view as to what counts as fraud for tax matters. Some courts have even said taxpayers can be held accountable for fraud committed by their tax return preparers.

When considering fraud, there is a question as to what activities are considered. Take for example the civil tax fraud penalty. This civil penalty applies to understatements of tax. This means that the relevant timeframe would seem to be the time leading up to and culminating with the filing of the tax return. Once the tax return is filed, the fraudulent has been completed.

What about additional actions by the taxpayer to further the fraud? For example, submitting false or altered documents to the IRS auditor who is examining the fraudulent tax return? Can those actions be considered evidence of fraud for the understatement of tax? The court recently answered this question Chopra v. Commissioner, T.C. Memo. 2025-2.

Facts & Procedural History

The taxpayer in this case is a healthcare consultant. She has several advanced college degrees.

The case involves her 2019 individual income tax return. The taxpayer filed her tax return and reported substantial business expense deductions and itemized deductions. This included more than $68,000 in medical expenses and nearly $90,000 in business expenses.

The IRS pulled her tax return for audit and requested documentation to substantiate the claimed deductions. The IRS auditor proposed adjustments for the larger items on the tax return and also proposed a civil fraud penalty.

The civil fraud penalty was due to the taxpayer’s failure to cooperate. This continued during the litigation in the tax court. The court described the conduct by the taxpayer as follows:

  • She provided only partial credit card statements to the IRS auditor (5 months out of 12)
  • She refused to produce partnership tax returns and agreements for the flow through income
  • She made false representations to the court about discussing matters with opposing counsel
  • She provided documents that appeared to be digitally altered
  • She offered implausible explanations when questioned about inconsistencies

The tax court ultimately upheld both the underlying tax deficiency and a civil fraud penalty. This article focuses on the fraud penalty.

Traditional Badges of Fraud vs. Procedural Conduct

The civil tax fraud penalty is found in Section 6663 of the tax code. It is a very short statute that just says that the taxpayer can be liable for a 75 percent penalty for any underpayment of tax that is attributable to fraud.

The IRS has the burden to prove that there was tax fraud. To do this, the IRS has to show that the taxpayer engaged in conduct with the intent to evade taxes that he knew or believed to be owing. The IRS also has to prove that the understatement of tax was due to the fraud.

There are several prerequisites implicit in these rules. For example, the taxpayer has to actually file a tax return. This provides one “out” for this penalty. For example, a document that is filed that does not qualify as a “tax return” cannot trigger this penalty. The tax return may not have to be signed for there to be fraud, but it does have to be intended to be a valid tax return and it has to be filed. Those who file a frivolous tax return or those do not file a tax return cannot be subject to this penalty.

As a separate note, it is often advisable to file a tax return, even if the tax return is being filed late, to get the statute of limitations for the IRS to audit and make an assessment. However, the tax return has to be an honest and truthful return to avoid for this to work and to avoid the fraud penalty. The taxpayer then has to contend with the late filing penalty.

Also, those who do not believe that intentionally file a false return under a genuine belief that they are complying with the law do not trigger this penalty. These concepts are not set out in the tax code. They are found in various court cases involving this penalty.

The Badges of Fraud

Section 6663 also does not provide a definition for the term “fraud.” The courts have developed factors that are used to establish fraud. These so-called “badges of fraud” typically focus on the taxpayer’s conduct at or before the time of filing of the tax return, such as:

  • Maintaining false books and records
  • Creating fictitious documents
  • Concealing income or assets
  • Making false statements to investigators
  • Dealing extensively in cash
  • Filing false documents

There are quite a few court cases that apply factors like these. The courts have largely said that no one factor is determinative, and then they essentially pick the set of factors that are relevant to the case. In many cases there is one fact triggers several of these factors, such as in cases where a fictitious business is reported on a tax return for a tax loss. The business is reported on the return, but the taxpayer may maintain false books and records or create false or fictitious documents to support it–as the court suggested that the taxpayer did in this case.

The tax court cases that address fraud penalties are largely sustained in the IRS’s favor. Even in those cases where the taxpayers prevail on the fraud penalty, the tax court still usually imposes the lesser 20 percent accuracy or negligence penalty.

Conduct After the Tax Return is Filed

This brings us to the question posed by this article. Can conduct after the tax return is filed be considered as one of the “badges of fraud” for the understatement of tax on the tax return?

The understatement of tax happened at the time the tax return was filed. By the time the IRS audits the tax return, several years have usually passed. By the time the case gets to tax court, several more years have passed.

This Chopra case is a prime example. It is a tax court case with an opinion issued in 2025 for a 2019 income tax return. The court in Chopra did in fact find that the taxpayer’s post-tax return filing conduct supports a finding of fraud for the civil tax fraud penalty.

The tax court specifically identified several aspects of the taxpayer’s procedural conduct as badges of fraud:

  • Failure to cooperate with tax authorities
  • Providing implausible or inconsistent explanations
  • Offering testimony lacking credibility
  • Refusing to produce relevant documents
  • Making false representations to the court

The tax court even noted that the taxpayer’s “duplicitous and obstructive behavior throughout this [court] case is a badge of fraud” for the Section 6663 penalty.

The court made this ruling even though it has its own separate penalty for fraudulent conduct during tax litigation which is found in Section 6673. The Section 6673 penalty is limited to $25,000, which the Section 6663 fraud penalty is not. The opinion does not address the Section 6673 penalty so, presumably, the court did not impose this additional penalty.

The Takeaway

This case shows that conduct during tax audit and litigation matters as it can be additional evidence of fraudulent intent for any understatement on the tax return. Producing fraudulent documents to the IRS auditors and making false statements to the court can be evidence of fraudulent intent. While taxpayers retain their rights to challenge IRS positions and limit document production, they should exercise these rights in a way that doesn’t create additional evidence of fraud.

Watch Our Free On-Demand Webinar

In 40 minutes, we’ll teach you how to survive an IRS audit.

We’ll explain how the IRS conducts audits and how to manage and close the audit.  



Source link

Do FBAR Penalties Die With the Taxpayer? – Houston Tax Attorneys

Risk Redux — Conflicts of the Father…, More on Judicial Recusal Reasons, Another Law Firm Data Breach

IRS Levy for a Debt It Already Agreed to Payment Over Time? – Houston Tax Attorneys

Copyright © 2024 All Rights Reserved.