U.S. v. Galletti, Abel, et al. (03/23/2004)

Questions presented: Whether, in order to enforce the derivative liability of partners for the tax debts of their partnership, the United States must make a separate assessment of the taxes owed by the partnership against each of the partners directly?

BY ELIZABETH WEILL-GREENBERG, MEDILL NEWS SERVICE

The Gallettis and Briguglios were very familiar with the difficulties of navigating the terrain of the business world.

After finding success in the wholesale food business, the Gallettis and Briguglios -- two brothers-in-law and their wives decided to open a hotel and marina in San Pedro, California. Another family member joined their venture and became a partner.

Unfortunately they opened their hotel in the late 1980s, when the US hit an economic recession. Their business failed after about two years.

By the time the Gallettis went to see an attorney, they were more than $13 million in debt. They filed for bankruptcy in October 1999; the Briguglios filed for bankruptcy in February 2000.

In bankruptcy court the Gallettis and Briguglios learned that they owed the IRS almost $400,000 in unpaid employment taxes from 1992-1995. Penalty fees made up more than $240,000 - or about 60% - of their debt. In early 2000, the IRS filed proofs of claim against the Briguglios and Gallettis.

Years earlier, the IRS had sent an assessment to the partnership about the unpaid taxes. But the partners were not individually contacted and were unaware that they owed the debts. Under California law, partners are primarily liable for unpaid taxes. According to federal law, after the initial debt assessment is made, a hearing does not have to be held for an additional ten years.

Since the IRS does not classify partners as taxpayers, partners do not have to be individually contacted only the partnership itself has to be assessed. The IRS believes "an assessment is merely a formal record of the amount of tax that is due."

But the bankruptcy court disagreed. The court ruled that the IRS had to individually assess each partner. Because the partners had not been assessed within the required three years, the statute of limitations had run out and the IRS was barred from collecting its debt.

The IRS lost each of its appeals first at the federal district court, then in the 9th Circuit Court of Appeals.

The 9th Circuit opinion was unanimous. The court found that because the Gallettis and Briguglios were individual taxpayers, they must be individually assessed

"The Partnership is a taxpayer within the meaning of the statute, but so is each individual Debtor a separate taxpayer subject to assessment for this tax," wrote Judge Susan Graber. The panel ruled that "although under state law each individual partner is liable for the debts of the partnership, a claim against the partnership does not automatically give rise to a right to collect against the individual partners."

According to the courts opinion, its decision did not conflict with the 7th Circuits 1995 ruling in U.S. v. Wright because, in that case, although the statute of limitations had run out, the IRS had assessed both the partnership and the individual taxpayers.

On June 23, 2003, the U.S. Supreme Court accepted review in the case.

The Gallettis and Briguglios are willing to pay the unpaid taxes but not the penalty fees, said David Haberbush, their attorney, in an interview. The IRS is scared of the precedent a settlement could set, Haberbush said. The IRS claimed that ten billion dollars is at risk in this case.

"The IRSs $10 billion wound will be entirely self-inflicted if it comes to pass," according to the Gallettis and Briguglios. "Without a name the assessment is incomplete recording a liability without a name is a fruitless act."

And they claimed, it also violates the due process clause of the 5th and 14th Amendments by not notifying individual partners of the assessment and penalties.

"Surely, thirteen years of interest and penalties, without recourse, is not fundamentally fair," their brief stated.

On March 23, 2004, the Court held unanimously for the U.S., concluding that the tax assessment was sufficient to extend the statute of limitations to collect the tax in a judicial proceeding from the general partners who were liable for the payment of the partnerships debts.

Justice Clarence Thomas wrote the Court's unanimous opinion.

Attorneys: For U.S.:THEODORE B. OLSONSolicitor General, Counsel of RecordEILEEN J. O'CONNORAssistant Attorney GeneralKENT L. JONESAssistant to the Solicitor GeneralTHOMAS J. CLARKANDREA R. TEBBETS