Fehlhaber v. C.I.R.

• Decision Date: 24 February 1992
• Docket Number: No. 90-5735,90-5735
• Citation: 954 F.2d 653
• Parties: -850, 60 USLW 2571, 92-1 USTC P 50,131 Robert FEHLHABER, Petitioner-Appellant, v. COMMISSIONER, INTERNAL REVENUE SERVICE, Defendant-Appellee.
• Court: U.S. Court of Appeals — Eleventh Circuit

Page 653

954 F.2d 653

69 A.F.T.R.2d 92-850, 60 USLW 2571,

92-1 USTC P 50,131

Robert FEHLHABER, Petitioner-Appellant, v. COMMISSIONER, INTERNAL REVENUE SERVICE, Defendant-Appellee.

No. 90-5735.

United States Court of Appeals, Eleventh Circuit.

Feb. 24, 1992.

Mitchell S. Fuerst, John S. Bohatch, Jerome S. Richman, Edward P. Guttenmacher, Miami, Fla., for petitioner-appellant.

Gary R. Allen, Janet Kay Jones, Brian C. Griffin, Ann B. Durney, U.S. Dept. of Justice, Tax Div., Washington, D.C., for respondent-appellee.

Appeal from a Decision of the United States Tax Court.

Before DUBINA, Circuit Judge, HENDERSON and CLARK, ^* Senior Circuit Judges.

CLARK, Senior Circuit Judge:

This case presents the issue whether the limitations period for assessing a deficiency against an individual taxpayer, attributable solely to his investment in a subchapter S corporation, commences from the date the individual files his return or the subchapter S corporation files its tax return.

I.

Subchapter S of the Internal Revenue Code ¹ extends to certain eligible small business corporations a unique tax status closely analogous to that of a partnership. Unlike a subchapter C corporation, an S corporation is not separately taxed at the ordinary corporate rates, but is generally treated as a "pass through" entity under which income and losses flow directly to the shareholders. ² The subchapter S corporation files only an informational return (Form 1120-S) which reports its gross income, deductions, shareholders, and their pro rata share of each item for the taxable year. ³ The shareholders then include their share of the S corporation's income, gain, losses, deductions, and credits on their own personal returns. ⁴

Taxpayer Robert Fehlhaber was the sole shareholder of a small business corporation, Fehlhaber Associates, Inc. This subchapter S corporation timely filed its tax return on Form 1120-S for its fiscal year ended November 30, 1985. The return reported that Fehlhaber Associates had incurred a loss of $79,166 for the fiscal year. Fehlhaber timely filed his 1985 individual return on or before April 15, 1986 and reported this loss to reduce his overall tax liability. During an audit of Fehlhaber's individual return, the Internal Revenue Service determined that Fehlhaber Associates had not actually sustained the loss passed through to Fehlhaber. The Service disallowed this loss and sent a statutory notice of deficiency to Fehlhaber, dated April 12, 1989, informing him of this disallowance and a resulting increase in his tax liability of $59,041 plus penalties. Although the notice was issued to Fehlhaber within three years of the time that he filed his individual return, it was issued more than three years after the S corporation return was filed.

Fehlhaber subsequently filed a petition with the Tax Court contesting the Service's determination of a deficiency. Relying on the Ninth Circuit's decision in Kelley v. Commissioner, ⁵ Fehlhaber moved for summary judgment on the ground that the period of limitations for assessing a deficiency based on adjustments to Fehlhaber's individual return relating to the subchapter S corporation had expired prior to the issuance of the notice of deficiency. In a fully reviewed opinion, the Tax Court denied Fehlhaber's motion for summary judgment, ⁶ and we granted his motion for an interlocutory appeal to this court.

II.

Section 6501 of the Internal Revenue Code establishes the period of limitation for assessing any tax imposed under the Code. It states that "the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed." The Service contends that this language unambiguously states that the three-year period of limitations for assessing a tax begins to run from the date of the filing of the return of the person or entity against whom the tax is asserted. Because the only tax liability at issue in this case is that of Fehlhaber and not the S corporation, the Service argues that its notice of deficiency, dated April 12, 1989, was issued within three years of the filing of Fehlhaber's 1985 individual return. In contrast, Fehlhaber contends that the notice of deficiency is time barred under section 6501 because the disallowed loss was attributable to the S corporation and was therefore asserted more than three years after the filing of the corporation's returns. We agree with the Tax Court's conclusion that Fehlhaber's reading of section 6501 is inconsistent with both the language of the statute and the overall structure of subchapter S.

In authorizing the provisions of subchapter S, Congress sought to replicate the tax treatment of partnerships for certain eligible small business corporations. The principal feature of this model of taxation is that an S corporation is a "flow through" entity; the corporation is generally not subject to the corporate income tax and its income is taxed directly to its shareholders under personal income tax rates. ⁷ Thus, the return filed by an S corporation, not subject to income taxation, is merely an informational return because it does not reflect any corporate tax liability. ⁸ Such a return does not contain other relevant information about a taxpayer such as his adjusted basis in the corporate stock, filing status, exemptions, deductions, or income, losses, or credits from other sources--all information necessary to calculate his tax liability and determine any deficiency. ⁹ As the Tax Court noted, the taxable year of the S corporation which ended on November 30, 1985 does not correspond to Fehlhaber's own tax year which ended on December 31, 1985. ¹⁰ In sum, an S corporation return cannot be the basis for the assessment of any tax liability against either the entity or the individual shareholder: the corporation itself is ordinarily not subject to any tax and the return lacks sufficient information to determine the individual's tax liability. In this case, we therefore conclude that the limitations period for adjustments relating solely to subchapter S items did not commence from the time that Fehlhaber Associates filed its S corporation return because no tax liability could be assessed from it. ¹¹ As a result, the Service's notice of deficiency was not time barred.

Fehlhaber, however, relies on section 6037 to support his view that the limitations period began when his S corporation filed its return. Section 6037 sets out the requirement that every S corporation must file an annual return and states in its last sentence that "[a]ny return filed pursuant to this section shall, for purposes of chapter 66 (relating to limitations), be treated as a return filed by the corporation under section 6012." There are, however, several difficulties with Fehlhaber's reading of this statute. Most importantly, section 6012 provides, in relevant part, that "[e]very corporation subject to taxation under subtitle A " is required to file an income tax return. ¹² This reference strains Fehlhaber's interpretation because, as we noted above, an S corporation is a "flow-through" entity and is not generally separately taxable. It is clear that the last sentence in section 6037 does not apply to a subchapter S corporation unless its return establishes that the corporation owes a tax. Fehlhaber's subchapter S tax return reflected no tax liability on the part of the corporation.

Common sense dictates this result. Section 6501, supra, requires that "the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed." ¹³ A tax can only be assessed if the tax return establishes an amount certain that the taxpayer owes. The Commissioner cannot audit a return and issue a notice of deficiency unless presented with the taxpayer's final calculations. The three year statute of limitations starts when such a return is filed. Fehlhaber's tax return with final calculations showing amount due triggered the commencement of the limitations period and was deemed filed April 15, 1986. The legislative history of subchapter S amply supports this reading of section 6037. This section was enacted into law by the Technical Amendments Act of 1958. ¹⁴ The Senate Report to this Act specifically commented on the meaning of section 6037:

Notwithstanding the fact that an electing small-business corporation is not subject to the tax imposed by chapter 1 of the 1954 Code, such corporation must make a return for each taxable year in accordance with new section 6037.... Such return will be considered as a return filed under section 6012 for purposes of the provisions of chapter 66, relating to limitations. Thus, for example, the period of limitations on assessment and collection of any corporate tax found to be due upon a subsequent determination that the corporation was not entitled to the benefits of subchapter S, will run from the date of filing of the return required under the new section 6037. ¹⁵

We concede that the one example provided by this Report as to the scope of section 6037 does not necessarily imply that the limitations period begins to run from the time that a shareholder files his individual return when the S corporation is not found to be separately taxed. ¹⁶ However, the Service's interpretation of this section, which we adopt, was reaffirmed by Congress during the significant revisions to subchapter S by the Subchapter S Revision Act of 1982. ¹⁷ In recounting the state of the law immediately prior to the significant changes rendered by that Act, the Senate Report noted that:

[u]nder present law, a taxpayer's individual tax liability is determined in proceedings between the Internal Revenue Service and the individual whose tax liability is in dispute. Thus, any issues involving the income or deductions of a subchapter S corporation are determined separately in administrative or judicial proceedings involving the individual shareholder whose tax liability is affected. Statutes of limitations apply at the...