Marshall v. Commonwealth

• Decision Date: 03 January 2012
• Citation: 41 A.3d 67
• Parties: Robert J. MARSHALL, Jr., Petitioner v. COMMONWEALTH of Pennsylvania, Respondent.
• Court: Pennsylvania Commonwealth Court

41 A.3d 67

Robert J. MARSHALL, Jr., Petitioner
v.
COMMONWEALTH of Pennsylvania, Respondent.

Commonwealth Court of Pennsylvania.

Argued June 8, 2011.Decided Jan. 3, 2012.

[41 A.3d 70]

Joseph C. Bright, Philadelphia, for petitioner.

Kevin A. Moury, Harrisburg, for respondent.

BEFORE: LEADBETTER, President Judge, and PELLEGRINI, Judge, and SIMPSON, Judge, and LEAVITT, Judge, and BROBSON, Judge, and McCULLOUGH, Judge, and BUTLER, Judge.¹OPINION BY Judge BROBSON.

“The hardest thing in the world to understand is the income tax.” These words by Albert Einstein ring particularly true in this case. On its face, the Pennsylvania personal income tax (PIT) seems simple enough. Residents and nonresidents are obligated to remit a tax on each dollar of income at a rate of 3.07%.² For residents, that percentage applies to all income received in a taxable year. For nonresidents, the percentage applies only to income from sources within the Commonwealth. As this case illustrates, however, particular circumstances can morph a relatively simple mathematical computation into a Gordian knot. Here, the Court must consider application of the PIT to a nonresident, who invested as a limited partner in a Connecticut limited partnership, which owned a building in the City of Pittsburgh, which went into foreclosure.

I. BACKGROUND³

Petitioner Robert J. Marshall, Jr. (Marshall) challenges a Board of Finance and Revenue (Board) Order, which confirmed a decision by the Department of Revenue (Revenue) imposing PIT on Marshall, a nonresident,⁴ for “income” from the foreclosure of a commercial property in the City of Pittsburgh (Property) in 2005. 600 Grant Street Associates Limited Partnership (Partnership), organized under Connecticut law, purchased the Property for $360 million.⁵ Of this $360 million purchase price, the Partnership financed $308 million with a Purchase Money Mortgage Note (PMM Note) secured only by the Property. The PMM Note was nonrecourse,

[41 A.3d 71]

meaning that the Partnership and the lender agreed that the lender's only recourse for nonpayment of the obligations under the PMM Note was to pursue foreclosure of the Property. As the name of the Partnership suggests, the Partnership's primary purpose was the ownership and management of the Property.

Interest on the PMM Note accrued on a monthly basis at a rate of 14.55%. If, however, the monthly accrued interest exceeded the net operating income of the Partnership, the Partnership was not required to pay the excess ( i.e., the amount of monthly accrued interest less monthly net operating income). Instead, the accrued but unpaid excess would be deferred and, thereafter, compounded on an annual basis subject to the same interest rate as the principal amount of the PMM Note. The original maturity date of the PMM Note was November 1, 2001. In 1998, the lender and the Partnership amended the PMM Note to extend the maturity date to January 2, 2005.

Marshall purchased a limited partnership interest (one unit) in the Partnership on or about January 24, 1985, for $148,889—$5,889 in cash and a promissory note of $143,000. His one unit limited partnership interest amounted to a 0.151281% interest in the Partnership. Marshall paid the promissory note in full on or about May 13, 1992. In March 1989, the Partnership returned a portion of Marshall's capital contribution in the amount of $6,184. Marshall was a passive investor in the Partnership. He never participated in the management of the Partnership or the Property.

Over the years, the Partnership's net income from operations did not keep pace with projections. The Partnership actually incurred losses from operations for financial accounting, federal income tax, and PIT purposes every year of its existence. For PIT purposes, the Partnership allocated its annual losses from operations to each partner, including Marshall. During this same time, Marshall had no other Pennsylvania source of income or loss. Marshall thus did not file a PIT return for tax years 1985 through 2004.

Because of the Partnership's dismal operations, the Partnership paid less monthly interest on the PMM Note than it had projected. Under the terms of the PMM Note, this led to a greater amount of accrued but unpaid interest over the years. According to the Offering Memorandum, the Partnership projected accrued but unpaid interest on the PMM Note at maturity (November 1, 2001, later extended to January 2, 2005) to be approximately $300 million. It also projected that upon sale of the Property at maturity, there would be enough proceeds to pay off the principal and accrued interest on the PMM Note, with additional funds available to distribute to the partners as a return on their investment. (Stip.¶¶ 32, 33.) At the date of foreclosure, the Partnership had an accrued but unpaid interest obligation of approximately $2.32 billion. ( Id. ¶ 37.) The Partnership had used approximately $121,600,000 of this amount to offset its income from operations that would otherwise have been subject to PIT. Neither the Partnership nor Marshall derived any PIT benefit from the remainder. ( Id. ¶ 38.)

The lender foreclosed on the Property on June 30, 2005. By that time, what began as a $308 million Partnership liability on the PMM Note had grown into a liability of more than $2.6 ⁶ billion, of which only $308 million represented principal. Neither the Partnership nor its individual partners received any cash or other property

[41 A.3d 72]

as a result of the foreclosure. That same year, the Partnership terminated operations and liquidated. Marshall did not recover his $142,705 capital investment (original investment less return of capital) in the Partnership at foreclosure or liquidation. Indeed, Marshall did not receive any cash or other property upon liquidation of the Partnership.

In a Notice of Assessment dated March 28, 2008, Revenue assessed Marshall $165,055.24 in PIT for calendar year 2005 (inclusive of penalties and interest) as a result of the foreclosure on the Property (Assessment). Marshall filed a petition for reassessment with Revenue's Board of Appeals (BOA), challenging the imposition and, in the alternative, amount of PIT set forth in the Assessment. On September 12, 2008, BOA struck the penalties from the Assessment, but otherwise held that the amount of PIT due, with interest, was proper. Marshall appealed BOA's determination to the Board, which denied Marshall's request for relief from the BOA's determination on December 16, 2008. This appeal ⁷ followed.

Marshall raises several issues for our consideration, which we will restate for purposes of our analysis. First, Marshall argues that because neither the Partnership nor the partners received any cash or other property upon foreclosure of the Property, no PIT is owed as a result of the foreclosure. Second, Marshall argues that imposition of an income tax on a taxpayer, like himself, who actually derived no income from his investment is prohibited by our prior decision in Commonwealth v. Rigling, 48 Pa.Cmwlth. 303, 409 A.2d 936 (1980), and the court of common pleas' decision in Commonwealth v. Columbia Steel & Shafting Co., 83 Pa. D. & C. 326 (Dauphin 1951), exceptions dismissed, 62 Dauph. 296 (Dauphin 1952). In his third issue, Marshall argues that application of the PIT to him in this instance is unconstitutional, because it treats him differently from the partners who reside in Pennsylvania. ⁸ Fourth, Marshall claims that Revenue failed to apply the tax benefit rule—both generally and as set forth in the Pennsylvania Personal Income Tax Guide (PIT Guide),⁹ which Revenue publishes on its website—in calculating the amount of PIT Marshall owes. Finally, Marshall argues that he is not subject to the PIT because he lacked sufficient minimum contacts with Pennsylvania.

II. ANALYSIS A. Minimum Contacts

We are compelled to take Marshall's arguments out of order, because if he is not subject to PIT, it matters not whether Revenue properly calculated his PIT liability. Marshall argues that he is not subject

[41 A.3d 73]

to PIT because he is not a resident of the Commonwealth and does not have sufficient minimum contacts with the Commonwealth, such that the Commonwealth may tax him without violating the Commerce and Due Process Clauses of the United States Constitution.¹⁰ Relying on paragraph 9 of the Stipulation, Marshall's argument is as follows:

Here, Mr. Marshall had no minimum contacts with Pennsylvania. He did not reside in or conduct any activities in Pennsylvania. Similarly, his interest in the Partnership was never employed as capital or localized in connection with a trade or business so as to establish a business situs for the interest of Pennsylvania. Without such minimum contacts, a state may not tax an individual whose only connection with the state is a passive limited partnership interest in a partnership doing business in that state.(Marshall Br. at 28 (emphasis added).)

We conclude that Marshall has waived his Commerce Clause challenge. In Quill Corporation v. North Dakota, 504 U.S. 298, 112 S.Ct. 1904, 119 L.Ed.2d 91 (1992), the United States Supreme Court held that “the Due Process Clause and the Commerce Clause are analytically distinct” and, thus, analysis of the two should not be intermingled. Quill, 504 U.S. at 305–06, 112 S.Ct. 1904. In his Brief, Marshall argues only that he lacks “minimum contacts” with the Commonwealth. “Minimum contacts” is the test to determine whether application of a state's tax scheme to a nonresident violates due process. See id. at 306, 112 S.Ct. 1904; Equitable Life Assurance Soc'y of the U.S. v. Murphy, 153 Pa.Cmwlth. 338, 621 A.2d 1078, 1091 (1993). Whether a taxing scheme violates the Commerce Clause requires application of a four-part test, the first prong of which requires a court to consider whether the tax “is applied to an activity with a substantial nexus with the taxing State.” Quill, 504 U.S. at 311, 112 S.Ct. 1904; Equitable Life, 621 A.2d at 1093....