Frank A. LITTRIELLO, Plaintiff-Appellant, v. UNITED STATES of America and Unit╜ed States Department of Treasury, De╜fendants-Appellees., United States Court of Appeals, Sixth Circuit., 484 F.3d 372, No. 05-6494., Decided and Filed: April 13, 2007
Frank A. LITTRIELLO, Plaintiff-Appellant, v. UNITED STATES of America and Unit╜ed States Department of Treasury, De╜fendants-Appellees.
United States Court of Appeals, Sixth Circuit.
484 F.3d 372
Decided and Filed: April 13, 2007.
Argued: July 21, 2006.
Decided and Filed: April 13, 2007.
ARGUED : Irwin G. Waterman, Seiller Waterman LLC, Louisville, Kentucky, for Appellant. Bridget M. Rowan, United States Department of Justice, Washington, D.C., for Appellees. ON BRIEF : Irwin G. Waterman, Michael T. Hymson, Seiller Waterman LLC, Louisville, Kentucky, for Appellant. Bridget M. Rowan, David I. Pincus, United States Department of Jus╜tice, Washington, D.C., for Appellees.
Before KENNEDY and DAUGHTREY, Circuit Judges; ADAMS, District Judge.*
* ═ The Honorable John R. Adams, United States District Judge for the Northern District of Ohio, sitting by designation.
MARTHA CRAIG DAUGHTREY, Circuit Judge.
In this appeal from a grant of sum╜mary judgment to the government, we are presented with a case of first impres╜sion regarding the validity of the Trea╜sury Department's so-called "check-the-box" regulations, 26 C.F.R. ╖╖ 301.7701-1 to 301.7701-3, promulgated in 1996 to simplify the classification of business enti╜ties for tax purposes.
The plaintiff, Frank Littriello, was the sole owner of several Kentucky limited liability companies (LLCs), the operation of which resulted in unpaid federal em╜ployment taxes totaling $1,077,000. Be╜cause Littriello was the sole member of the LLCs and had not elected to have the businesses treated as "associations" ( i.e. , corporations) under Treasury Regulations ╖╖ 301.7701-3(a) and (c), the LLCs were "disregarded" as separate taxable entities and, instead, were treated for federal tax purposes as sole proprietorships under Treasury Regulation ╖ 301.7701-3(b)(1)(ii). When Littriello, as sole proprietor, failed to pay the outstanding employment taxes, the IRS filed notices of determination and, eventually, notified him of its intent to levy on his property to enforce previously filed tax liens. Littriello responded by initiat╜ing complaints for judicial review in dis╜trict court, contending that the regulations in question (1) exceed the authority of the Treasury to issue regulatory interpreta╜tions of the Internal Revenue Code; (2) conflict with the principles enunciated by the Supreme Court in Morrissey v. Com╜missioner , 296 U.S. 344, 56 S.Ct. 289, 80 L.Ed. 263 (1935); and (3) disregard the separate existence of an LLC under Ken╜tucky state law. He also argued in his motion for summary judgment that the regulations are not applicable to employ╜ment taxes. After the cases were consoli╜dated for disposition, the district court held that the "check-the-box regulations" are "a reasonable response to the changes in the state law industry of business for╜mation," upheld them under Chevron 1 analysis, and held that the plaintiff was individually liable for the employment tax╜es at issue. We conclude that the district court's analysis was correct and affirm.
1. ═ Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc. , 467 U.S. 837, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984).
PROCEDURAL AND FACTUAL BACKGROUND
Frank Littriello was the owner of sever╜al business entities, including Kentuckiana Healthcare, LLC; Pyramid Healthcare Wisc. I, LLC; and Pyramid Healthcare Wisc. II, LLC. Each of these businesses was organized as a limited liability compa╜ny under Kentucky law, with Littriello as the sole member. He did not elect to have them treated as corporations for federal tax purposes and, as a result, none of the LLCs was subject to corporate income tax╜ation. For the tax years in question, Lit╜triello reported his income from the three businesses on Schedule C of his individual income tax return-the schedule on which the profits and losses of a sole proprietorship are reported. Because the LLCs were "disregarded entities" under the per╜tinent tax regulations, and not corporate entities, the IRS assessed Littriello for the full amount of the unpaid employment tax╜es for 2000-2002.
In January 2003, the Internal Revenue Service informed Littriello that it intended to enforce the liens that had been filed against his property as security for the unpaid taxes. In response, Littriello requested a hearing, which produced a de╜termination by the IRS Appeals Office that Littriello was individually liable as a sole proprietor under Treasury Regulation ╖ 301.7701-3(b)(1)(ii), as a result of his failure to elect to be treated as a corporation.
Littriello filed suit in district court con╜testing the finding of liability and contend╜ing, among other things, that Treasury Regulations ╖╖ 301.7701-1-301.7701-3 (the "check-the-box regulations") were invalid. Relying on Chevron , t he district court re╜jected Littriello's challenge to the regula╜tions. The district court upheld the as╜sessment against Littriello, ruling that the governing provisions of the Internal Reve╜nue Code, found in 26 I.R.C. ╖ 7701, were ambiguous and that the IRS's regulatory interpretation, including the check-the-box provisions, was "a reasonable response to the changes in the state law industry of business formation." This appeal followed.
The Treasury Regulations at the heart of this litigation, 26 C.F.R. ╖╖ 301.7701-1-301.7701-3, were issued in 1996 to clarify the rules for determining the classification of certain business entities for federal tax purposes, replacing the so-called "Kintner regulations." 2 The earlier regulations had been developed to aid in classifying busi╜ness associations that were not incorporat╜ed under state incorporation statutes but that had certain characteristics common to corporations and were thus subject to tax╜ation as corporations under the federal tax code. Corporate income is, of course, sub╜ject to "double taxation"-once at the cor╜porate level under I.R.C. ╖ 11(a) and again at the individual-shareholder level, pursu╜ant to I.R.C. ╖ 61(a)(7). In contrast, part╜nership income benefits from "passthrough" treatment-it is taxed once, not at the business level but only after it passes through to the individual partners and is taxed as income to them, pursuant to I.R.C. ╖╖ 701-777. A sole proprietor╜ship-in which a single individual owns all the assets, is liable for all debts, and oper╜ates in an individual capacity-is also taxed only once.
2. ═ See United States v. Kintner , 216 F.2d 418 (9th Cir.1954).
The Kintner regulations built on an even earlier standard, set out by the Supreme Court in Morrissey , in which the Court addressed the tax code provision that in╜cluded an "association" within the defini╜tion of a corporation, in order to determine whether a "business trust" qualified as an "association" for federal tax purposes. 296 U.S. at 346, 56 S.Ct. 289. Morrissey iden╜tified certain characteristics as those typi╜cal of a corporation, including the exis╜tence of associates, continuity of the entity, centralized management, limited personal liability, transferability of ownership inter╜ests, and title to property. Id . at 359-61, 56 S.Ct. 289. However, the Court did not hold that a specific number of those char╜acteristics had to be present in order to establish the business entity as a corpora╜tion, nor did it address the consequence of a partnership having some of those charac╜teristics, leaving the distinctions between and among the various defined entities less than clear.
Meant to clarify some of the confusion created in the wake of Morrissey , t he Kintner regulations developed four essen╜tial characteristics of a corporate entity and provided that an unincorporated busi╜ness would be treated as an "associa╜tion"-and, therefore, as a corporation rather than a partnership-if it had three of those four identifying characteristics. See former Treas. Reg. ╖╖ 301.7701-2(a)(1) and (3). The Kintner regulations, adequate to provide a measure of predictability at the time of their promulgation in 1960 and for several decades afterward, proved less than adequate to deal with the new hybrid business entities-limited lia╜bility companies, limited liability partner╜ships, and the like-developed in the last years of the last century under various state laws. These unincorporated business entities had the characteristics of both cor╜porations and partnerships, combining ease of management with limited liability, and were increasingly structured with the Kintner regulations in mind, in order to take advantage of whatever classification was thought to be the most advantageous. The "Kintner exercise" required skillful lawyering by business entities and case-by-case review by the IRS; it quickly came to be seen as squandering of resources on both sides of the equation.
As a result, the IRS undertook to re╜place the Kintner regulations with a more practical scheme, consistent with existing tax statutes and with a new provision in I.R.C. ╖ 7704 treating publicly-traded enti╜ties as corporations, regardless of their structure or status under state law. As to the unincorporated business associations not covered by ╖ 7704, including the newly emerging hybrid entities, the IRS pro╜posed to allow an election by the taxpayer to be treated as a corporation or, in the absence of such an election, to be "disre╜garded," i. e. , deemed a partnership (for entities with multiple members) or a sole proprietorship (for those with a single member). After a period for notice and comment, the new regulations were issued and became effective on January 1, 1997, implementing the definitional provisions of ╖╖ 7701(a)(2) and (3). The regulations were particularly helpful with regard to the tax status of the new hybrids, because the hybrid entities were not, and still are not, explicitly covered by the definitions set out in ╖ 7701. What was avoided by the resulting "check-the-box" provisions was the necessity of forcing those hybrids to jump through the Kintner regulation "hoops" in order to achieve a desired-and perfectly legal-classification for federal tax purposes.
The district court noted that Littriello's unincorporated businesses had not elected to be treated as corporations under the new regulations and were, therefore, deemed by the IRS to be sole proprietor╜ships. This result provided Littriello with a major tax advantage: his income from the healthcare facilities would be taxed to him only once. But, of course, it also meant that he would be responsible not only for taxes on business income but also for those federal employment taxes that were required by statute and that had not been paid for the years in question.
The district court found that the regula╜tions were a reasonable interpretation by the IRS of a tax statute (I.R.C. ╖ 7701) that was otherwise ambiguous, upheld them under Chevron analysis, after noting that it was apparently the first court asked to review those regulations, and held Littriello individually liable for the amounts assessed by the IRS. In doing so, the district court rejected Littriello's argu╜ments that the Secretary of the Treasury had exceeded his authority in promulgat╜ing the entity-classification regulations, that the regulations are invalid under Morri ssey , and that they impermissibly altered the legal status of his state-law-created LLC. Before this court, Littriello also con╜tends that the regulations do not apply to employment taxes, an argument that de╜pends, at least in part, on proposed amendments to the entity-classification regulations that were not circulated until after the appeal in this case was filed.
A. Chevron Analysis
The first two arguments raised by Littriello are intertwined. He contends that the statute underlying the "check-the-box" regulations is unambiguous and that the district court's invocation of Chevron was, therefore, erroneous. Under Chev╜ron , a court reviewing an agency's inter╜pretation of a statute that it administers must first determine "whether Congress has directly spoken to the precise question at issue." 467 U.S. at 842, 104 S.Ct. 2778. If congressional intent is clear, then "that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Con╜gress." Id . at 842-43, 104 S.Ct. 2778. However, "if the statute is silent or ambig╜uous with respect to the specific issue, the question for the court is whether the agen╜cy's answer is based on a permissible con╜struction of the statute." Id. at 843, 104 S.Ct. 2778; see also Barnhart v. Thomas , 540 U.S. 20, 26, 124 S.Ct. 376, 157 L.Ed.2d 333 (2003) (when a statute is silent or ambiguous, the court must "defer to a reasonable construction by the agency charged with its implementation").
Littriello argues, first, that Chevron has been modified by the Supreme Court's re╜cent decision in National Cable & Telecommunications Ass'n v. Brand X Internet Services , 545 U.S. 967, 125 S.Ct. 2688, 162 L.Ed.2d 820 (2005), which "seems to revise the Chevron formula by substituting as the second agency requirement ▒reason╜ableness' for ▒permissible construction of the statute.' " But this argument over╜looks the fact that the Chevron opinion uses the terms "reasonable" and "permis╜sible" interchangeably in reference to stat╜utory construction. See, e.g., 467 U.S. at 843, 845, 104 S.Ct. 2778. Second, and more substantially, he posits that the regu╜lations run afoul of Morrissey , " the semi╜nal case on ╖ 7701," which he reads to hold that the IRS is legally required to deter╜mine the classification of a taxpayer-busi╜ness within the definitions set out in the statute and may not "abdicate the responsibility of making that determination to the taxpayer itself" by permitting an election of classification such as a "check-the-box" option.
Although the plaintiff's Morrissey argu╜ment is not a model of clarity, it seems to depend on the proposition that the terms defined in ╖ 7701 ("corporation," "associa╜tion," "partnership," etc.) are not ambigu╜ous but "[have been] in common usage in Anglo American law for centuries" and, as a corollary, that " Morrissey provides a test of identification [that is itself] unam╜biguous." Hence, the argument goes, it is the "check-the-box" regulations that "ren╜der whole portions of the Internal Reve╜nue Code ambiguous" and are therefore "in direct conflict with the decision of the Supreme Court in Morrissey " in t he ab╜sence of Congressional amendment to ╖ 7701.
It is unnecessary, in our judg╜ment, to engage in an exegesis of Chevron here. The perimeters of that opinion and its directive to courts to give deference to an agency's interpretation of statutes that the agency is entrusted to administer and to the rules that govern implementation, as long as they are reasonable, are clear, and are clearly applicable in this case. More╜over, the argument that Morrissey has somehow cemented the interpretation of ╖ 7701 in the absence of subsequent Con╜gressional action or Supreme Court modi╜fication is refuted by Chevron , in which the Court suggested that an agency's interpre╜tation of a statute, as reflected in the regulations it promulgates, can and must be revised to meet changing circum╜stances. See Chevron , 4 67 U.S. at 863-64, 104 S.Ct. 2778. Even more to the point, the Court in Morrissey observed that the Code's definition of a corporation was less than adequate and that, as a result, the IRS had the authority to supply rules of implementation that could later be changed to meet new situations. See 296 U.S. at 354-55, 56 S.Ct. 289. Finally, we note that our interpretation is buttressed by the opinion in National Cable , on which the plaintiff relies to support the proposi╜tion that the "check-the-box" regulations are impermissible in light of Morrissey. In that case, the Supreme Court noted that "[a] court's prior judicial construction of a statute trumps an agency construction otherwise entitled to Chevron deference only if the prior court decision holds that its construction follows from the unambig╜ uous terms of the statute and thus leaves no room for agency discretion." Nat'l Ca╜ble , 5 45 U.S. at 982, 125 S.Ct. 2688 (em╜phasis added).
In short, we agree with the dis╜trict court's conclusions: that ╖ 7701 is ambiguous when applied to recently emerging hybrid business entities such as the LLCs involved in this case; that the Treasury regulations developed to fill in the statutory gaps when dealing with such entities are eminently reasonable; that the "check-the-box" regulations are a valid ex╜ercise of the agency's authority in that respect; that the plaintiff's failure to make an election under the "check-the-box" pro╜vision dictates that his companies be treat╜ed as disregarded entities under those reg╜ulations, thereby preventing them from being taxed as corporations under the In╜ternal Revenue Code; and that he is, therefore, liable individually for the em╜ployment taxes due and owing from those businesses because they constitute sole proprietorships under ╖ 7701, and he is the proprietor.
B. Status Under State Law
Citing United States v. Galletti , 5 41 U.S. 114, 124 S.Ct. 1548, 158 L.Ed.2d 279 (2004), Littriello argues that the IRS must recognize the separate existence of his LLCs as a matter of state law. We conclude that the opinion is inapplicable here. Galletti involved a partnership, not a disregarded entity, that was assessed as an employer for unpaid employment taxes. See id. at 117, 124 S.Ct. 1548. The part╜ners, who were liable for partnership debts under state law, contended that they should therefore also be assessed as "em╜ployers," but the Court held as a matter of federal law that "nothing in the Code re╜quires the IRS to duplicate its efforts by separately assessing the same tax against individuals or entities who are not the actual taxpayers but are, by reason of state law, liable for payment of the taxpay╜er's debt." Id. at 123, 124 S.Ct. 1548. Hence, the Court in Galletti was con╜cerned with a business actually organized as a partnership and not a disregarded entity deemed a sole proprietorship for federal tax purposes. Of course, partner╜ships are recognized entities under federal tax law and explicitly included in ╖ 7701's definitions, while single-member LLCs are not. See I.R.C. ╖ 7701( a)(2).
The same flaw prevents application of the ruling in People Place Auto Hand Carwash, LLC v. Commissioner , 126 T.C., 359 (2006), to the facts here. In this re╜cent opinion, submitted as supplemental authority by Littriello, the Tax Court held that imposition of an employment tax on the LLC could not be viewed as equivalent to the imposition of an employment tax on its members. Again, however, the LLC in People Place had more than a single mem╜ber and, because it had not opted to be treated as a corporation, it was perforce treated as a partnership. But under no circumstances could Littriello's single-member LLCs be treated as partnerships for federal tax purposes-his choice was to elect treatment of each of them as a corpo╜ration or, in the absence of an election, have them treated as sole proprietorships.
The federal government has historically disregarded state classifications of busi╜nesses for some federal tax purposes. In Hecht v. Malley , 2 65 U.S. 144, 44 S.Ct. 462, 68 L.Ed. 949 (1924), for example, the United States Supreme Court held that Massachusetts trusts were "associations" within the meaning of the Internal Reve╜nue Code despite the fact they were not so considered under state law. As courts have repeatedly observed, state laws of incorporation control various aspects of business relations; they may affect, but do not necessarily control, federal tax provi╜sions. See, e.g., Morrissey , 296 U.S. at 357-58, 56 S.Ct. 289 (explaining that com╜mon law definitions of certain corporate forms do not control interpretation of fed╜eral tax code). As a result, Littriello's single-member LLCs are entitled to what╜ever advantages state law may extend, but state law cannot abrogate his federal tax liability.
C. Proposed Amendments to the Regulations
In October 2005, after the notice of appeal in this case had been filed, the IRS circulated a notice of proposed rule-mak╜ing that set out possible amendments to the entity-classification regulations that would shelter individuals similarly situated to Littriello for unpaid employment taxes. The proposed amendments would treat "single-owner eligible entities that current╜ly are disregarded as entities separate from their owners for federal tax purposes . . . as separate entities for employment tax and related reporting requirements." Disregarded Entities; Employment and Excise Taxes, 70 Fed.Reg. 60475 (pro╜posed Oct. 18, 2005) (to be codified at 26 C.F.R. pts. 1.301). Thus, if the amend╜ments had been in place when the tax deficiencies in this case arose, single-member LLCs such as Littriello's would be treated as separate entities for employ╜ment tax purposes, although not for other federal tax purposes.
Littriello argues that the proposed amendments should be taken as reflecting current Treasury Department policy and applied to his case. But, it appears that the changes contemplated by the amend╜ments are intended to simplify employ╜ment tax collection procedures and do not represent an endorsement of the position that Littriello has advocated in this litiga╜tion. As the Supreme Court noted in Commodity Futures Trading Commission v. Schor , 478 U.S. 833, 106 S.Ct. 3245, 92 L.Ed.2d 675 (1986):
It goes without saying that a proposed regulation does not represent an agen╜cy's considered interpretation of its stat╜ute and that an agency is entitled to consider alternative interpretations be╜fore settling on the view it considers most sound. Indeed, it would be anti╜thetical to the purposes of the notice and comment provisions of the Administra╜tive Procedure Act, 5 U.S.C. ╖ 553, to tax an agency with "inconsistency" whenever it circulates a proposal that it has not firmly decided to put into effect and that it subsequently reconsiders in response to public comment.
Id . at 845, 106 S.Ct. 3245. As the IRS urges, we conclude that "[b]ecause the fur╜ther development of permissible alterna╜tives is part of the administering agency's function under Chevron , the proposed reg╜ulations do not in any way undermine the District Court's determination that the current regulations are reasonable and valid." Plainly, an agency does not lose its entitlement to Chevron deference merely because it subsequently proposes a differ╜ent approach in its regulations. 3
3. ═ As of the date of this opinion, the proposed regulations have not been adopted.
For the reasons set out above, we reject the plaintiff's challenge to the "check-the-box" regulations and AFFIRM the district court's grant of summary judgment to the defendant.