Beard v. U.S.

• Decision Date: 11 June 1993
• Docket Number: No. 92-6296,92-6296
• Citation: 992 F.2d 1516
• Parties: -5197, 93-1 USTC P 50,359 Charles D. BEARD, Jr.; Mary Sue Beard, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee. John G. BEARD; Louise H. Beard, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Eleventh Circuit

Page 1516

992 F.2d 1516

72 A.F.T.R.2d 93-5197, 93-1 USTC P 50,359

Charles D. BEARD, Jr.; Mary Sue Beard, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.

John G. BEARD; Louise H. Beard, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.

No. 92-6296.

United States Court of Appeals Eleventh Circuit.

June 11, 1993.

Jack W. Selden, U.S. Atty., Caryl P. Privett, Birmingham, AL, Gary R. Allen, Tax Div., Dept. of Justice, Janet Kay Jones, Brian C. Griffin, Richard Farber, Steven Parks, Washington, DC, for defendant-appellee.

Appeal from the United States District Court for the Northern District of Alabama.

Before FAY and KRAVITCH, Circuit Judges, and RONEY, Senior Circuit Judge.

KRAVITCH, Circuit Judge:

The Subchapter S Revision Act of 1982 (SSRA), Pub.L. 97-354, 96 Stat. 1669 (currently codified at 26 U.S.C. §§ 6241-45 (1988)), generally requires shareholders in S corporations to follow the same procedures which partners in partnerships must follow to contest adjustments made by the Internal Revenue Service (IRS) to their business entity's tax return. 26 U.S.C. § 6244. The sole question in this case is whether Congress exempted from those procedures S corporations having ten or fewer shareholders, just as it exempted partnerships with ten or fewer partners. See id. § 6231(a)(1)(B). We agree with the district court that Congress did not mandate such an exception for small S corporations. Regulations promulgated by the Secretary of the Treasury do except from the procedures S corporations having five or fewer shareholders, but those regulations became effective on January 30, 1987, and thus do not apply to appellants in this case. See 26 C.F.R. § 301.6241-1T(c)(2). Accordingly, we affirm the district court's grant of summary judgment in favor of the government.

I.

Appellants Charles D. Beard, Jr., Mary Sue Beard, John G. Beard, and Louise H. Beard were the only shareholders in Alabama Home Health Care Services (Alacare), ¹ an S corporation for federal income taxation purposes. See 26 U.S.C. § 1362. In the early 1980s, Alacare acquired the assets of another health care corporation. Those assets included various claims against Medicare and Medicaid. After attempting unsuccessfully to collect these claims, Alacare took deductions related to the claims on its 1983 and 1984 income tax returns. ² Because S corporations pass deductions through to their shareholders, see infra Part II.A., appellants claimed pro rata shares of the deductions on their personal income tax returns.

In 1988 the IRS audited Alacare's 1983 and 1984 returns and disallowed the deductions the corporation had taken with respect to the uncollected Medicare and Medicaid claims. The IRS properly notified appellants of the disallowances. The notices informed appellants that the correct way to contest the adjustment was to "file a petition for a readjustment of the S corporation items with the United States Tax Court, the United States Claims Court, or the District Court of the United States." ³

Despite this warning, appellants did not petition for readjustment of the S corporation items. They did not, that is, contest the disallowance of the deductions in a single proceeding at the corporate level. Instead, appellants paid the additional taxes which the IRS asserted they owed. They then filed with the IRS individual claims for refunds. When the IRS denied their refund requests, appellants brought the instant tax refund suits in their individual capacities.

At the government's request, the district court consolidated appellants' actions. The court then granted summary judgment in favor of the government on the ground that the court lacked subject matter jurisdiction to entertain those actions. The court held that the Internal Revenue Code requires aggrieved shareholders to challenge IRS adjustments to their S corporation's return in one unified proceeding, not separate refund suits, regardless of the size of the S corporation. ⁴

The district court's construction of the Code presents a question of law, which we review de novo.

II.

A.

An S corporation is a small business corporation ⁵ which has elected to have its income taxed according to the provisions of subchapter S of the Code's chapter on normal income taxes, 26 U.S.C. §§ 1361-79. See 26 U.S.C. § 1361(a)(1). It generally does not pay income taxes as an entity. Id. § 1363(a). Rather the corporation files only an informational return reporting for the taxable year its gross income (or loss) and deductions (collectively "items" ⁶); its shareholders; and the shareholders' pro rata shares of each item. Fehlhaber v. Commissioner, 954 F.2d 653, 654 (11th Cir.1992). The items are then "passed through" on a pro rata basis to the shareholders, who report them on their personal income tax returns. 26 U.S.C. § 1366(a). The S corporation is, in effect, a Code-created hybrid combining traits of both corporations and partnerships. It is a corporation for non-tax purposes, retaining, among other features, the corporate hallmark of limited liability for its shareholders. At the same time, the Code treats it largely as a partnership, taxing most of its income at the individual rather than the entity level. ⁷ Fehlhaber, 954 F.2d at 654.

Although partnerships do not pay taxes as a business unit, they ordinarily are treated as entities for the limited purposes of reporting, assessing, and contesting partnership items. ⁸ Thus, in the Tax Treatment of Partnership Items Act of 1982 (TTPIA), Pub.L. 97-248, §§ 401-06, 96 Stat. 324, 648-71, (codified at 26 U.S.C. §§ 6221-31 & 6233), ⁹ Congress established comprehensive procedures for unified determinations of deficiencies and refunds attributable to partnership items. When the IRS concludes that a partnership's tax return underreports income or erroneously claims losses or deductions, the IRS must issue to all known partners ¹⁰ a notice of final partnership administrative adjustment, informing them of an adjustment to the partnership return. 26 U.S.C. § 6223(a). The partners may contest the adjustment only in a single, unified proceeding; ¹¹ challenges by individual partners in the form of separate refund suits are not allowed. Id. § 6221 ("Except as otherwise provided in this subchapter, the tax treatment of any partnership item shall be determined at the partnership level."); id. § 7422(h) ("No action may be brought for a refund attributable to partnership items," with two exceptions not relevant to this case). Prior to the enactment of this procedure for unified audits and litigation, the IRS had to issue separate notices of deficiency to each partner. As a result, issues regarding partnership items had to be resolved separately in what might be a large number of individual cases. The unified-litigation requirement promotes judicial economy and consistency of results, and facilitates comprehensive settlements, by enabling the courts and the IRS to address issues affecting the entire partnership in a single forum. See, e.g., H.R.Conf.Rep. No. 97-760, 97th Cong., 2d Sess. 599 (1982), reprinted in 1982 U.S.C.C.A.N. 781, 1190, 1371.

One important exception exists to the general rule that partners must contest adjustments to partnership items in a unified proceeding. Congress excluded from the definition of "partnership" for purposes of the unified audit and litigation procedures partnerships with "10 or fewer partners each of whom is a natural person (other than a nonresident alien) or an estate." 26 U.S.C. § 6231(a)(1)(B)(i)(I). ¹² Thus, partners in "small" partnerships may challenge an assessment attributable to partnership items by bringing individual tax refund suits. ¹³

Congress enacted the SSRA shortly after it enacted the TTPIA. In 26 U.S.C. § 6244, Congress made applicable to S corporation items

[t]he provisions of--

(1) [the TTPIA] which relate to--

(A) assessing deficiencies, and filing claims for credit or refund, with respect to partnership items, and

(B) judicial determination of partnership items ...

except to the extent modified or made inapplicable in regulations.

Appellants concede that section 6244 generally incorporates by reference into the SSRA the unified litigation requirements which the TTPIA imposes upon most partners and partnerships. They assert that that fact is immaterial because section 6244 also extends to S corporations and their shareholders the small partnership exception contained in 26 U.S.C. § 6231(a)(1)(B). We disagree with appellants' interpretation of section 6244.

B.

Distilled to its essence, appellants' argument is that section 6244 sets forth a special definition for "S corporation" for purposes of the SSRA. That definition is derived, the argument goes, by simply "overlaying the word 'partnership' with 'S corporation,' and the word 'partner' with 'shareholder,' " in section 6231(a)(1)(B). Arenjay Corp. v. Commissioner, 920 F.2d 269, 271 (5th Cir.1991), cited in Appellants' Initial Brief at 5. The problem with this argument is that federal law already expressly defines the term "S corporation" for purposes of the SSRA. That definition does not include a small S corporation exception applicable to appellants in this case.

On January 30, 1987, ostensibly in response to the absence of an explicit definition of S corporation in the SSRA, the Secretary of the Treasury promulgated a temporary regulation defining S corporation for purposes of the unified litigation procedures. See 26 C.F.R. § 301.6241-1T(c) (1987). That regulation resembles closely the definition of partnership in 26 U.S.C. § 6231(a)(1). The regulation provides that, in general, the term "S corporation" means "any corporation required to file a return under section 6037(a)." ¹⁴ 26 C.F.R. § 301.6241-1T(c)(1). Compare 26 U.S.C. § 6231(a)(1)(A) (In general "the term 'partnership' means any partnership required to file a return under section 6031(a)."). It then excludes from the definition "small" S...