Government Forces Sale to Cover Partner’s Tax Debt

 I was reading a case recently that bothered me. It involves something that – fortunately – I rarely see in practice.

Here is the Code section:

§ 7403 - Action to enforce lien or to subject property to payment of tax

(a) 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.

(b) Parties. All persons having liens upon or claiming any interest in the property involved in such action shall be made parties thereto.

(c) 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.

(d) 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.

And here is where you leave your tax CPA and hire a tax attorney.

Section 7403 permits a court to authorize the sale of property when a delinquent person owns property with a nondelinquent person. The IRS cannot do this on its own power, however; it must first go to district court and obtain approval.

To be fair, one is deep into the IRS Collection machinery before Section 7403 is even an issue. I would be screaming at you – and likely fired you as a client – long before we got here, unless bad fortune was involved. If there was bad fortune, we likely would be submitting an offer in compromise.

The heavyweight case in this area is United States v Rodgers. Rodgers was a Texas gambler who died, leaving a $900,000 tax debt. He (well, now his estate) and his wife owned their home. Under Texas law the surviving spouse had a lifetime right to live in the home. The government of course wanted its money.

The case went all the way to the Supreme Court, which identified four issues before the government could force any sale to collect taxes.

 (1) Statutory authority

Does the taxpayer have any “right, title or interest” to the property in question?

 

In Rodgers, yes. The deceased had the same rights to the entire home as did the widow.

 

The type of ownership can have a drastic effect on the government’s ability to reach the asset. A tenancy by the entirety, for example, might result in a different answer from a tenancy in common (which we will see below). 

            (2) Constitutional authority

This goes back to eminent domain. The government is not an ordinary creditor in this situation; rather it is exercising the prerogatives of a sovereign. Think of the government as a super creditor.

            (3) Practical undercompensation

Think actuarial calculations. For example, one could think that a 50/50 split of marital assets is fair. However, the value of a life estate to a surviving spouse aged fifty can be up to 95% of the home’s sales price. The spread between 95% and 50% is referred to as “practical undercompensation.”

            (4) Four-factor balancing test

             (a)  Will a non-sale prejudice the government?

   (b) Does the spouse have a legally recognized expectation of the house not being sold?

   (c)  Will the spouse suffer prejudice from practical undercompensation and dislocation costs?

   (d)  What are the relative characters and values of the two ownership interests?

Subsequent application of Rodgers focuses on these four factors.

Let’s move on to Driscoll.

Thomas Driscoll was a dentist. He owned a dental practice with Dr Vockroth. Together they also owned the building in which the dental practice was located.

Common enough.

Dr Driscoll became substantially delinquent with his tax obligations.

In April 2023, the government filed a motion for forced sale of both the practice and the building.

Meanwhile. Dr V had no tax issues. He may have made the mistake of partnering with someone who did, but that was the extent of his culpability.

The government – to its credit – allowed additional time to sell both assets.

But there were issues: trying to sell a dental practice in a small town and a building housing said practice in said small town. Let’s just say there was limited interest in buying either.

The government now wanted a forced sale.

Let’s go through the Rodgers four factors:

One

The Court decided Dr V could not show that the government would not be prejudiced by going after 50% rather than 100% of the practice and building.

Yes, the double negative is a bit difficult to follow.

This was a practice in a small town. It was going to be tough enough to sell without trying to sell half rather than the whole.

         The court decided that factor one weighed in favor of a sale.

         Two

Was Dr V as a tenant in common subject to a forced sale?

Here is the Court discussing the real estate:

This conclusion is also supported by the fact that, unlike tenants by the entirety or joint tenants, tenants in common enjoy no protections from forced sales or partition actions.”

Tough to be a tenant in common in New Jersey.

The court decided factor two weighed in favor of a sale.

Three

 Was there prejudice to Dr V in terms of personal dislocation of costs and undercompensation of interest?

Here is the Court:

 Dr Vockroth asserts that he will be ‘forced to lay off all of [his] employees,’ and that he will ‘no longer be able to see [his]  patients.'”

OK, Dr V may be laying it on thick, but that does not mean there is no truth here. Relocating a practice costs money. There are – for example - additional electrical and plumbing needs before a building can house a dental practice. Patients may not follow. Employees may not follow. The court is playing cavalierly with other people’s lives.

Here is the court in its best Frasier Crane voice:

 Furthermore, even if Dr Vockroth is negatively affected by the LLC in some way, this is not an undue prejudice of a magnitude to prevent a forced sale. It is axiomatic that LLCs and partnerships change, fail, dissolve and are bought and sold with regularity. Partners die or sell their shares The reality is simply part of being in business, and Dr. Vockroth is not exempt from this fact, especially when he fails to offer any reliable evidence to support his contentions.”

What is Dr V to do: poll his patients and employees to see whether they would follow? Oh, that will go swimmingly.

BTW the sale of a dental practice will certainly include a noncompete, meaning that Dr V could not open a dental practice within so many miles of the existing practice. Well, he could, but he would be sued.

One would think a judge would know that.

Four

  The relative character and value of the property owned by the two owners.

There was not much play here as both doctors owned 50%.

The court decided that the government could foreclose on both the practice and the real estate.

Technically right, but lousy law. Consider this menacement from Rodgers:

We do emphasize, however, that the limited discretion accorded by § 7403 should be exercised rigorously and sparingly, keeping in mind the Government's paramount interest in prompt and certain collection of delinquent taxes.

Section 7403 is not taxpayer friendly.

Our case this time was United States v Driscoll, 2025 BL 2655, D.N.J. No. 3:18-cv-11762, 1/6/25.

New Jersey and the Telecommuter

We are visiting state taxation today. Our trip this time will take us to New Jersey, and it will highlight how tax law can simultaneously arrive at a technically correct but bumble-headed conclusion.

Let’s say you manufacture parts in New Jersey. Would you expect to file and pay state income tax to New Jersey?

That one is easy - of course. You are doing business there – in the meaningful sense of the phrase. You have a building, you have employees. You park your car out front. You visit Chipotle for lunch. You are there.

Let’s make this more challenging. You do not manufacture parts. You do not manufacture anything. You develop software. Your offices are in Rockville, Maryland. You do not have offices in New Jersey. You do not park your car in New Jersey or visit their Chipotle for lunch. You are not there. You have an employee who moves to New Jersey. You like her. You keep her on board.

Like a Jim Croce song, you have a name.  Your name is Telebright.

Let’s have her work from her new home. She begins her workday at 9:00 a.m. by checking with her project manager, who is based in Boston. She receives daily work assignments. When done, she uploads her work and sends it to you. She is expected to work 40 hours a week. She could live on the moon, for what location matters to her work.

She does not solicit customers. She does not have sales responsibility. She does not refresh products, or stock shelves, or install, or service. She does not supervise employees. She does not have management authority. You do not even reimburse for her office-in-home. She travels twice a year to Maryland. By the way, you do not pay for the travel – rather she pays for those trips out of her own pocket.

You – being enlightened – take New Jersey withholding taxes out of her paycheck so that she has no rude April 15^th surprise.

New Jersey surfaces, somewhat like the mutant alligator in a bad Sci-Fi network movie. New Jersey says that you are doing business in the state, and it wants you to … (wait on it) … pay corporate income taxes!

The case goes before the New Jersey Tax Court. The court cites the New Jersey statute:

Every domestic or foreign corporation which is not hereafter exempted shall pay an annual franchise tax for each tax year, as hereafter provided … for the privilege of doing business , [or] employing or owning capital or property … in this state.”

The Court then reflects philosophically:

The term ‘doing business’ is used in a comprehensive sense and includes all activities which occupy the time or labor of men for profit.”

It rolls up its sleeves and grittily reviews the law (N.J.A.C. 18:7-1.9(b)):

Whether a foreign corporation is doing business in New Jersey is determined by the factors in each case. Consideration is given to such factors as:

(4) The employment in New Jersey of agents, officers and employees.”

Oh, oh. This is going to go wrong, isn’t it? Or is it possible the court will recognize that a lone employee in the state hardly amounts to a corporate beachhead?  Here is the Court:

There is no one, single controlling factor nor is there a bright line standard that determines whether a foreign corporation’s in-state activities meet the Director’s regulatory requirements for doing business. Rather, it is only by close scrutiny of all the facts of the case, taken as a whole, that a final determination can be made. ”

It then digs in like a free agent seeking a new sports contract and drives for the bright line.

It cannot be disputed that plaintiff satisfies factor 4 … by employing Ms. … in New Jersey.”

[Telebright] agreed to permit Ms. … regularly to perform her duties at her New Jersey home.”

This consistent contact with New Jersey was not sporadic, occasional or intermittent.”

But the Court pauses. Will it realize that you are being a good sport for even keeping her employed after the move? Will it acknowledge that this is not a 19^th century economy, when a county seat could not be more than a day’s travel for any resident of the county? It hesitates:

“While it is true that [Telebright] has never maintained an office in New Jersey, nor solicited business here ….”

No! Not now Tax Court of New Jersey! You are so close!

The Court shakes it off:

 … [its] daily contact with the State through its employee is sufficient to trigger application of the CBT Act.”

The mere fact that Ms. … is the only … employee in this State does not change the court’s decision.”

Yes, the court determined that Telebright was responsible for New Jersey corporate tax because it permitted an employee to work from her home in New Jersey.

Why does this upset me?

One reason is that reasoning like this would have me filing taxes with India if I hired an on-line bookkeeper there.

Another reason is that I have read court decisions like this for more than two decades now. After a while it is like watching WWE wrestling – there really isn’t much suspense about who is going to win. There was a time when a state at least tried to develop coherent doctrines and workable principles. In recent years however state tax has become more like a hijacking on a Sopranos episode.

Another reason is this is an employee-hostile decision.

I have a friend and client, for example, who lives in Kentucky and commutes to California. Yes, you read that right. He works a week here in Kentucky and a week near San Francisco. He is situated well enough at the company that he floated the idea of having an “office” here. The company turned him down. Why? Because they do not have a footprint in Kentucky and his “office” could create one. So he commutes every other week to California. I suspect he may be their only Kentucky-resident employee.

If you were Telebright, what would you do? Would you not permit your employee to work from home, never mind the reasons? Would you even keep her as an employee?

Who gains here? Tony … er, Trenton gets a few dollars from its next mark … er, taxpayer. Who loses? For now, the company loses. In the future, the loser will be the next employee who wants to work from a New Jersey residence for an out-of-state company whose tax advisor has read Telebright.