My Steadfast Partner, The IRS
If you’ve worked with the owners of closely held businesses for even just a few years, you have realized they are only half joking when they complain about having the government as a partner. Consider how much federal, state, and local tax[i] a business and its owners may pay over to the tax authority of each jurisdiction during the course of a taxable year.
If the business is treated as a partnership for tax purposes,[ii] the IRS is generally authorized to collect from the partnership any income tax deficiency arising out of the partnership’s operations for a taxable year, even if the persons who were partners in the year to which the deficiency relates are no longer partners in the year that the deficiency is assessed.[iii] Stated differently, the partnership’s current-year partners will bear the economic burden of the tax liability even though the tax adjustments relate to a prior year in which the composition of the partnership may have been different, and even though they themselves have satisfied their own tax liabilities.
In some cases, a business owner who may have reasonably delegated certain tax withholding and payment responsibilities to another owner or key employee (an officer, for example) of the business may still be held personally liable[iv] for a failure by the other owner or employee to collect and/or remit such taxes to the appropriate tax authorities.
Finally, and perhaps to the surprise of some, a co-owner of a business who has been diligent in satisfying their own tax liabilities may suffer an economic detriment as a result of government tax collection efforts against their less than tax-compliant co-owner. What follows is a description of one dentist’s (“Doc’s”) efforts to avert the forced sale of their practice and of the related real property that the dentist owned jointly with a tax-deficient fellow dentist and co-owner (“Taxpayer”).[v]
Paying Taxes Is Like Going To The Dentist, Except You Do All The Drilling
Taxpayer failed to pay federal income taxes for ten consecutive years.[vi] Taxes were assessed against Taxpayer but were never paid. In order to collect on the overdue taxes, the Government placed liens on Taxpayer’s property and rights to property,[vii] including Taxpayer’s 50% co-ownership interests in a dental office suite (the “Real Property”), and in a dental practice (the “LLC”) that operated from the Real Property.[viii] For each property, the other 50% interest was owned by Taxpayer’s fellow dentist and business partner, Doc.[ix]
The Government sought to collect the delinquent income taxes owed by Taxpayer. It petitioned the Court to force a sale[x] of the two properties, notwithstanding that Taxpayer owned only a partial interest therein,[xi] only Taxpayer owed back taxes to the Government, and the Government had placed liens only on Taxpayer’s interests in the properties.[xii]
Indeed, Doc did not owe taxes, was not responsible for his business partner’s (Taxpayer’s) delinquencies, and did not have liens placed on his property interests. Still, Doc was joined as a defendant because he could claim an interest in the properties involved in the action.[xiii]
Doc opposed the Government’s petition, objecting to the sale of the entirety of both properties and arguing instead for the Government to foreclose on Taxpayer’s interests alone. The Court gave the two partners time to sell both the properties and avoid a foreclosure. Months later, the parties represented to the Court that they were not able to reach any agreement of sale.[xiv]
The Court’s Analysis
The only issue before it, the Court stated, was whether the Government was permitted to conduct a forced sale of the entire Real Property and LLC, despite the fact that only Taxpayer – and not Doc – was delinquent on taxes.
According to the Court, while Doc owed no debts to the Government, the plain language of the Code[xv] contemplated “not merely the sale of the delinquent taxpayer’s own interest, but the sale of the entire property (as long as the United States has any ‘claim or interest’ in it).”[xvi]
It was clear, the Court stated, that “tak[ing] into account both the Government’s interest in prompt and certain collection of delinquent taxes and the possibilities that innocent third parties will be unduly harmed by that effort[,]” the Government was “entitled to a complete sale of both the Real Property and the LLC,” and judgment in its favor was appropriate.
Doc’s Position
The Court began by considering Doc’s argument regarding why his interest in the LLC could not be foreclosed upon; specifically, because the only appropriate remedy, according to Doc, was for the Government to file a charging order,[xvii] not a forced sale.[xviii]
The Court responded that although state law allowed a charging order as the “sole remedy of a judgment creditor,” the Government was not bound by the state laws of an ordinary creditor when it sought to foreclose pursuant to the Code.[xix] Furthermore, the Court continued, even if the Government were an ordinary creditor, state law would still not apply because the Court was dealing with “the effectuation of the underlying property interest.”[xx]
Therefore, the Court concluded that it may, in its discretion, order a forced sale of the entire LLC pursuant to the Code[xxi] so long as the so-called “Rodgers factors” (described below) were satisfied.
Foreclosure by the Government
The Court stated that the U.S. Supreme Court has recognized that the Government’s “power to enforce the obligations of the delinquent taxpayer” was “grounded in the constitutional mandate to lay and collect taxes.’”[xxii] Indeed, the Government “has the right to pursue the property of the delinquent taxpayer with all the force and fury at its command.” This power, the Court asserted, extends beyond the privileges of an ordinary creditor, and it is instead borne “out of the express terms of [the Code].”[xxiii]
The Court then explained that the Code contemplates a two-step process for the foreclosure of property to satisfy a tax debt. First, the Government can place a lien on any of the delinquent taxpayer’s pieces of property.[xxiv] Although a physical piece of real estate might be the most obvious target for a government lien, “the statutory language is broad and reveals on its face that Congress meant to reach every interest in property that a taxpayer might have. Stronger language could hardly have been selected to reveal a purpose to assure the collection of taxes.”
Once the lien is attached, the Court continued, the Government may file an action in district court to enforce the lien.[xxv] The district court is directed to adjudicate the merits of the potential foreclosure and, if the interest of the U.S. is established, the court “may decree a sale of such property.”[xxvi] As part of this adjudication, the district court was required to make party to the action “all persons having liens upon or claiming any interest in the property” at issue.[xxvii]
The Rodgers Factors
Having clarified the Government’s extensive ability to impose a lien and ultimately foreclose on a wide variety of properties, the Court added that the Government’s power was not limitless. “In the seminal case of United States v. Rodgers, the Supreme Court marked the contours of the Government’s power under [the Code] to force a judicial sale of a property when that sale might negatively affect an innocent third-party with no tax delinquency.”
In Rodgers, the Government sought foreclosure of an individual’s interest in the home he shared with his spouse. Under state law, however, the spouse was also entitled to an interest in the home, and therefore a sale of the entire home would deprive her of her property interest, despite the fact that she had no tax delinquency herself. The Court held that it must “read the statute to contemplate, not merely the sale of the delinquent taxpayer’s own interest, but the sale of the entire property.”
Nonetheless, the Court also held that Congress did not intend for a “district court to authorize a forced sale under absolutely all circumstances,” but that there is “limited room” in the statute for “the exercise of the [district court’s] reasoned discretion.”[xxviii]
The Rodgers court introduced a four-factor balancing test that was designed to “take into account both the Government’s interest in prompt and certain collection of delinquent taxes and the possibility that innocent third parties will be unduly harmed by that effort.” In determining whether a forced sale would cause undue hardship to an innocent third party, a court must consider:
(1) the extent to which the Government’s financial interests would be prejudiced it if were relegated to a forced sale of the partial interest actually liable for the delinquent taxes;
(2) whether the third party with a non-liable separate interest in the property would, in the normal course of events, have a legally recognized expectation that separate property would not be subject to forced sale by the delinquent taxpayer or his or her creditors;
(3) the likely prejudice to the third party, both in personal dislocation costs and in practical “undercompensation”; and
(4) the relative character and value of the non-liable and liable interests held in the property.
These factors are “not an exhaustive list,” the Court added, and observed that district courts are encouraged to rely on “common sense and consideration of special circumstances.” Still, despite the many considerations allowed on behalf of the non-liable third party, the “limited discretion accorded by [the Code] should be exercised rigorously and sparingly, keeping in mind the Government’s paramount interest in prompt and certain collection of delinquent taxes.”
The Rodgers Factors Applied
The Government exercised its authority under the Code to foreclose on two separate properties related to Taxpayer’s dental practice: the Real Property and the LLC. For each property, the Court applied the Rodgers factors to determine whether Doc’s interests outweighed the Government’s “paramount interest in prompt and certain collection” of taxes.
Taxpayer and Doc each owned a 50% stake of the Real Property as tenants in common; they each owned 50% of the LLC. In order to recover Taxpayer’s unpaid taxes, the Government imposed liens on Taxpayer’s 50% interest. The plain language of the Code permitted the Government to foreclose only on Taxpayer’s share of the Real Property and LLC, particularly since Taxpayer did not contest his delinquency and Doc would not object to such a sale. Rather, Doc only objected to the sale of his own 50% share in these properties. The Government wanted to sell the entire Real Property and LLC in order to best recoup what it was owed and “end this inefficient and wasteful use of taxpayer money.”
Doc argued that, applying the Rodgers test, the remedy of a complete forced sale was not justified because he would lose his investments, incur significant tax obligations, and be forced to displace his employees and patients.
Court’s Decision
The Court considered the forced sale of each property, as well as Doc’s arguments, and applied the Rodgers factor with respect to each property. But the Court also heeded the Rodgers Court’s warning against using the four factors as a “mechanical checklist,” and followed its direction to employ “common sense and consideration of special circumstances.”
According to the Court, the most salient additional considerations with regard to the Real Property were the impact of a forced sale on Taxpayer’s and Doc’s employees and patients, who were non-liable third parties. Doc asserted that he employed five people and cared for 5,000 patients. Each of these people – including Doc himself – might be inconvenienced, the Court stated, by a sale of the Real Property, or by having to work or go to the dentist in a new place that might not be as close by or as easily accessible. Alternatively, the Court opined, that a new location might be more advantageous for both Doc and his employees, and more convenient for his patients. Regardless, the Court did not find that the common-sense considerations discussed by the Rodgers Court underlying a forced sale of the Real Property weighed sufficiently in favor of halting the forced sale.
Next, the Court considered the impact that the sale of the dental practice (the LLC) may have on its patients and employees. The Court found that these considerations did not weigh against the forced sale. Aside from what the Court described as the “unsubstantiated, dire predictions” set forth in his brief and affidavit, Doc did not provide the Court with any expert report or analysis demonstrating his “doomsday speculations.” Those individuals were free to continue to associate with the LLC after the sale, or to find another dentist or place of employment. The Rodgers Court explicitly highlighted the “limited discretion accorded by [the Code]” and how such discretion “should be exercised rigorously and sparingly, keeping in mind the Government’s paramount interest in prompt and certain collection of delinquent taxes.” Given these restrictions, and the fact that the circumstances presented did not outweigh the Government’s “paramount interest in prompt and certain collection of delinquent taxes[,]” the Court determined that any equitable balancing weighed in favor of the forced sale of the LLC.
Having considered the four Rodgers factors and the above additional common-sense consideration of special circumstances, the Court concluded that the Government was entitled to foreclose on both the Real Property and the LLC in their entirety.
Partners Beware?
As we saw above, if a taxpayer is delinquent in satisfying a Federal tax liability, the Code authorizes the U.S. to initiate a civil action in the appropriate U.S. District Court to enforce its tax lien over the liability or to subject any of the delinquent taxpayer’s property or interest in property to the payment of that liability. As we also saw, when the U.S. files a complaint in District Court to enforce a lien, it is required to name all parties having liens on, or otherwise claiming an interest in, the relevant property as parties to the action.
As in the case of Taxpayer and Doc, these collection efforts may result – after the Court’s consideration of the Rodgers factors – in the forced sale of a business or investment in its entirety, rather than a sale of just the portion thereof owned by the delinquent taxpayer, notwithstanding the remaining interest in the property is owned by a non-liable third party; for example, the delinquent taxpayer’s business partner (like Doc).
How may an innocent partner protect themselves from the risk of such a forced sale? How may they retain control of their business and its assets? Can they remove the tax-delinquent partner?
Much will depend upon the presence of a carefully drafted partnership or operating agreement; for example, one that requires prompt disclosure of an audit or other tax proceeding by the delinquent partner – that’s a good start.
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The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.
[i] For example, income taxes on the taxable income of the business and of the owners; employment taxes on the compensation paid to employees (including owners); sales and use taxes on the purchase or sale of certain properties and services; transfer taxes on the disposition of real property; capital gain tax on the sale of the business; etc. It adds up pretty quickly.
[ii] Which generally includes an LLC with at least two members. Reg. Sec. 301.7701-3.
[iii] According to the governor’s latest budget proposal, New York State may soon be adopting the Federal partnership audit rules.
[iv] As a “responsible person,” usually with respect to employment taxes, or sales and use taxes.
[v] U,S. v. Thomas Driscoll, 2025 WL 30092 (U.S. District Court, D. New Jersey) Civil Action No. 18-11762 (RK) (RLS), Signed January 6, 2025.
[vi] You might say there was a substantial “gap” in his compliance.
[vii] IRC 6321 (allowing for a lien to be placed on “all property and rights to property” belonging to “any person liable to pay any tax neglects”). “Property” here refers not only to real property, but “all property and rights to property, whether real or personal.” See IRC Sec. 6321.
[viii] These were the only assets from which the entire tax deficiency may be satisfied.
[ix] Taxpayer and Doc owned Real Property as tenants in common.
[x] Pursuant to IRC Sec. 7403, which reads as follows:
- Filing
In any case where there has been a refusal or neglect to pay any tax, or to discharge any liability in respect thereof, whether or not levy has been made, the Attorney General or his delegate, at the request of the Secretary, may direct a civil action to be filed in a district court of the United States to enforce the lien of the United States under this title with respect to such tax or liability or to subject any property, of whatever nature, of the delinquent, or in which he has any right, title, or interest, to the payment of such tax or liability. For purposes of the preceding sentence, any acceleration of payment under section 6166(g) shall be treated as a neglect to pay tax.
- Parties
All persons having liens upon or claiming any interest in the property involved in such action shall be made parties thereto.
- Adjudication and decree
The court shall, after the parties have been duly notified of the action, proceed to adjudicate all matters involved therein and finally determine the merits of all claims to and liens upon the property, and, in all cases where a claim or interest of the United States therein is established, may decree a sale of such property, by the proper officer of the court, and a distribution of the proceeds of such sale according to the findings of the court in respect to the interests of the parties and of the United States. If the property is sold to satisfy a first lien held by the United States, the United States may bid at the sale such sum, not exceeding the amount of such lien with expenses of sale, as the Secretary directs.
- Receivership
In any such proceeding, at the instance of the United States, the court may appoint a receiver to enforce the lien, or, upon certification by the Secretary during the pendency of such proceedings that it is in the public interest, may appoint a receiver with all the powers of a receiver in equity.
[xi] Taxpayer did not dispute the tax liability and did not argue against the foreclosure of the property.
[xii] 7403(c) (allowing a district court to “decree a sale” and “distribute the proceeds of such sale” to satisfy the interests of the parties and of the United States).
[xiii] IRC Sec. 7403(b).
[xiv] During discussions of a possible sale, the Court had administratively terminated the Government’s pending Motion, and agreed not to consider it until contract negotiations concluded. The Motion was reinstated in November 2024.
[xv] IRC Sec. 7403.
[xvi] Citing, United States v. Rodgers, 461 U.S. 677 (1983).
[xvii] Basically, a court order pursuant to which the debt owed to a creditor is satisfied by allowing the creditor to seize the debtor’s share of any distributions made by a business entity in which the debtor has an interest.
[xviii] Doc also argued that, because the LLC was not a named party to the action, allowing a forced sale would violate the LLC’s due process rights. Doc relied on the fact that, under state law, LLCs were separate entities that did not take on the identities of their owners or shareholders. However, the LLC did not need to be joined, the Court responded, because both Taxpayer and Doc were joined in this action, they were the only people with decision-making power over the LLC’s activities, and they adequately represented the LLC’s interests in the case. Accordingly, the Court rejected this argument.
[xix] Citing Rodgers (“The Government’s right to seek a forced sale of the entire property in which the taxpayer has an interest does not arise out of its privileges as an ordinary creditor, but out of the express terms of §7403.”).
[xx] “Although the definition of the underlying property interests is left to state law, the consequences that attach to those interests is a matter left to federal law.”
[xxi] IRC Sec. 7403.
[xxii] Rodgers (quoting U.S. Const. art. I, sec. 8, cl. 1).
[xxiii] Citing IRC Sec. 7403.
[xxiv] IRC Sec. 6321.
[xxv] IRC Sec. 7403(a).
[xxvi] IRC Sec. 7403(c).
[xxvii] IRC Sec. 7403(b).
[xxviii] The Court relied in part on the term “may decree a sale of such property” in IRC Sec. 7403(c). (Emph. added)