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What
Could Happen if Your Partner (Member) Does Not Pay His Taxes Shown
on the K-1 from the LP or LLC?
Before you buy an Interest
in an
LP or LLC You Must Read This! Protecting Partnership and Partner’s
Assets from Tax Collections Claims
The IRS argues that a demand on the partnership
for delinquent taxes is a demand upon all the partners and is
sufficient to comply with both Section 6321 and 6303 of the IRC,
Thus taxes assessed against the partnership generates a lien on
the property of the individual partners.
Section 6321 creates
a federal tax lien by providing the following:
If any person liable to pay any tax neglects or
refuses to pay the same after demand, the amount…shall be
a lien in favor of the US upon all property and rights to property,
whether real or personal belonging to such person.
The lien imposed by Section 6321 arises when the
assessment is made and continues until either the taxpayer’s
liability is satisfied or the statue of limitations expires. The
IRS has ten years from the date of assessment in which to try
to collect the tax by judicial or administrative means.
There are 3 elements in the creation of a tax
lien:
- existence of a tax liability,
- a notice and demand from the IRS and,
- a neglect, inability, or refusal to pay the
tax liability.
The tax lien, once filed, attaches to any after-acquired
property. Thus, the tax lien automatically attaches to any property
or right to property that the taxpayer acquires during the life
of the tax lien. If the delinquent taxpayer is
the partner, the tax lien attaches to the partnership’s
interest held by the partner, but not the property of the
partnership.
If the delinquent taxpayer is the partnership,
the tax lien attaches to the partnership’s assets. Although
generally partnerships are not tax paying entities, they can be
responsible for tax like, SS, employment or excise taxes.
In this situation a lien against the partnership,
automatically becomes a lien against the partners (other than
the limited partners). Partnership Property Vs Partner’s
Property
This is based upon the intent of the partners,
because partners decide what is partnership property. Typically,
the following factors indicate partnership property:
- Property purchased with partnership funds
- Recorded title in the partnership
- Improvements made with partnership funds
- Payment of taxes, repairs, or insurance
- Listing on the partnership books or financial
statements
Partnership Property Vs Partnership
Interests
Again, if the delinquent taxpayer is the partner
and not the partnership, the tax lien attaches to the partner’s
interest in the partnership. Partnership property is owned by
the partnership, not the partners. A partnership interest is an
economic right, defined as a share of the partnership’s profits
and surplus, and is considered personality. This also includes
the partners right to participate in management. A partnership
interest is normally assignable. An assignee does not become a
new partner; he only has a right to distributions and to sell
them or mortgage them.
The IRS has two methods to enforce collection
of the money owed. A lien does not do that. It merely secures
the debt position of the IRS for the delinquent tax liability. The two methods of attack are;
- Lien-foreclosure suit,
section 7403(a).
- Administrative Levy,
more common, Section 6331 (a) includes the power of distraint
and seizure by any means. (does not require any judicial intervention).
The levy allows the IRS to attach or gain custody
of property in the possession of third parties or the taxpayer
and to do so in a summary fashion. A levy on property
in possession of the taxpayer is accomplished by seizure and sale
of the property.
The levy does not determine whether the government’s
rights to the seized property are superior to those of other claimants;
it does, however, protect the government against diversion or
loss while such claims are being resolved.
The IRS must provide the taxpayer with a 30 day
notice of intention to levy, but this is not required to be served
at the same time.
Most delinquent taxpayers are partners not
partnerships. The IRS would be looking
to seize the partner’s interest in distributions or sell
the partner’s interest to pay the debt. Partnership property
can not be seized and sold to enforce collection of taxes against
an individual partner.
If on the other hand, the partnership has the
tax liability, not only will the partnership property be available,
but the property of each partner may also be levied upon, since
a partner, other then a limited partner, is responsible for partnership
debts.
The liability of a limited partner, is dependent
upon state law and surrounding factual circumstances.
The challenge with all this is in a LIEN-FORECLOSURE
(Section 7403) different rules exist. In this case the Federal
court is sitting in equity and is not confined by the conventions
normally found in administrative IRS enforcement actions. The
court has the duty of determining the priority of all conflicting
claims to the property sought to be foreclosed. A tax debt
by a partner under Section 7403 can create potential trouble for
the assets of the partnership, if the government chooses
to get aggressive. For example, a federal court could
have the partnership dissolved so the delinquent partner would
now have money to pay the tax lien. (Mansfield case).
If you tell a bank, that your client has an
LP and, that if any limited partner has a tax lien, that will
not affect the partnerships assets, that may not be true.
The problem is not attachment of the tax lien, but foreclosure
of the lien by a federal court sitting in equity and the potential
forced sale of the entire fee merely to satisfy the tax liability
of the delinquent partner.
A federal tax lien is perfected by filing a notice
of tax lien. This lien has priority over certain third parties,
such as holders of security interests, purchasers, mechanic’s
liens, and judgement lien creditors. The challenge is for these
third parties is that they may not know there is a federal tax
lien.
The requirements for filing a notice of lien are;
- the notice of the lien filed in the proper
place -
if real property, in the county where the property
is located.
- the only way a deed will be valid is if entered
into and recorded in a public index.
When a tax lien is filed for a partnership and
corporation it is filed at the place of the principal executive
offices. This is where the major executive decisions are made.
This is different than the ra office, corporate office.
When a notice of tax lien is filled, the IRS must
give proper notice. In one case the IRS put the notice of tax
lien in the name of the partnership only, not the partner, and
it was determined that since the partner’s name was different
then the partnership name, that the partner was off the hook!
(A reason to have an unusual name for your LP).
The proposed transferor of personal property
may not have always lived in the same county of residence. To
avoid the risk of being subordinate to a federal tax lien, the
purchaser or holder of a security interest must examine the federal
tax lien records in every county of residence for the past 10
years. Likewise, a purchaser or creditor must search the records
of all partnerships to which the taxpayer belonged during the
past ten years.
Notice: Concerning
the above tax comments, keep the following in mind:
- This is how
the above tax strategy works generally.
- This assumes
that you are running a business with an honest "expectation of profit"
and "that your expenses are ordinary, necessary, reasonable and directly
related to your business."
- You document
the deductions correctly.
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