Lesson From The Tax Court: Corporations In The Bardo

Lincoln in The Bardo is not a book for everyone.  It’s main characters (none of whom are Lincoln) are caught in the bardo, an indeterminate space between death and final after-life, whatever one conceives that to be.  But they are slow to realize it, clinging to a belief in their continued existence as they were.  Filled with unreliable narrators and casually vacillating in time and space, the novel is not an easy read.  But it is well worth the effort, being a lovely meditation on the meaning of life and the meaning of death.

XC Foundation v. Commissioner, T.C. Memo. 2023-2 (Jan. 5, 2023) (Judge Lauber), is an easy read about a corporation in the bardo.  It teaches a practical lesson: always ensure that your corporate client is fully alive and well under state law before you try to file a petition.  There, a corporation attempted to file a petition to contest an IRS decision to revoke its 501(c)(3) status.  Well, actually, the corporation did not file the petition.  It couldn’t.  It was caught in a kind of bardo, an indeterminate space between corporate life and permanent corporate death.  California, the state that had given it life, had suspended its charter, killing its capacity to sue and be sued.  But like the characters in the novel, it ignored its own death and tried to convince the Tax Court to do so as well.  It turns out that taxpayers in the bardo cannot file petitions that the Tax Court can hear, just as Lincoln could not hear the pleas of the novel's characters.  They are the pleas of ghosts.  Details below the fold.

Law: Of Jurisdiction and Capacity
Jurisdiction is a fancy word for power.  Federal courts have only the power to hear those lawsuits Congress permits them to hear.  Congress puts those permissions in statutes.  So you have to pay attention to the words of the particular statute granting jurisdiction.  The Tax Court is no different than any other federal court in that regard, although for some reason it keeps asserting it is somehow more limited than other federal courts.  As the Seventh Circuit Court of Appeals once observed, that assertion is “fatuous.” Flight Attendants v. Commissioner, 165 F.3d 572, 578 (7th Cir. 1999) (Posner, J.) (“The argument that the Tax Court cannot apply the doctrines of equitable tolling and equitable estoppel because it is a court of limited jurisdiction is fatuous. All federal courts are courts of limited jurisdiction.”).

What is true, however, is that Congress gives the Tax Court a variety of more limited and specific grants of power than it gives federal district courts.  I think of the varied jurisdictional grants as different rooms of power.  For more on that see Lesson From The Tax Court: The Many Rooms Of Tax Court Power, TaxProf Blog (Oct. 4, 2021).

Taxpayers—both individuals and corporate entities—most often invoke the Tax Court’s deficiency jurisdiction by filing a petition to contest an IRS Notice of Deficiency (NOD).  The Tax Court says its deficiency jurisdiction is found in §6213.  Hallmark Research Collective v. Commissioner, 159 T.C. No. 6 (Nov. 29, 2022) (deficiency jurisdiction is in §6213 while jurisdiction to determine overpayments is in §6214).  For a strong pushback on that view, see Carl Smith, What’s Wrong With The Tax Court Hallmark Opinion: Part 2, Procedurally Taxing Blog (Dec. 7, 2022).  Today’s case, however, involves a different room of power, found in §7428 (“Declaratory judgments relating to status and classification of organizations under section 501(c)(3), etc.”).

Section 7428 creates a remedy for corporations like XC Foundation.  When the IRS either makes certain unfavorable decisions regarding their tax-exempt status or fails to make any decision within a certain amount of time after the corporation asks, the corporation can go to almost any federal court and file the appropriate pleading (called a Complaint in federal district court and, of the course, called a Petition in Tax Court).  However, §7428(b)(1) provides that “A pleading may be filed under this section only by the organization the qualification or classification of which is at issue.”  Section 7438(b)(3) also mirrors the §6213 deficiency procedure by providing that the pleading must be filed “before the 91st day after the date” the relevant IRS decision document is issued.

Notice that for both §6213 and §7428, the statutes are written in active voice: they tell us who must file a petition in order for the Tax Court to exercise its power: either the affected taxpayer or the affected organization.  Thus, I cannot file a petition asking the Tax Court to review an NOD issued to you, because I’m not the taxpayer.  Nor can I file a petition asking for a declaratory judgment regarding your corporation’s tax exempt status, because I’m not the corporation.

But the Tax Court implements these statutory phrases generously, using a doctrine of capacity.  That is, while the Tax Court does not have the power to hear a petition filed by me about your taxes because I don’t have the capacity to act in that regard, Rule 60(a) creates a ratification rule to deal with those situations: “[a] case timely brought shall not be dismissed on the ground that it is not properly brought on behalf of a party until a reasonable time has been allowed after objection for ratification by such party of the bringing of the case; and such ratification shall have the same effect as if the case had been properly brought by such party.” (emphasis supplied).

When it comes to corporations, the Tax Court thus permits a corporation whose petition was not properly filed to later ratify the filing,  But in order to do that the corporation must have had the capacity to engage in litigation at the time the petition was filed.  It cannot be in the bardo. Timbron Holdings Corporation v. Commissioner, T.C. Memo. 2019-31 (corporation not allowed to ratify petition when it did not have capacity at time of filing even when it later regained capacity under state law).

Tax Court Rule 60(c) says that the capacity of a corporate taxpayer to “to engage in such litigation shall be determined by the law under which it was organized.” Today’s case involves a California corporation, so let’s take a quick look at California law.

Like most states, California has rules for suspending corporate charters and then reinstating them.  You can find them in the California Revenue and Taxation Code (RTC) §23301 - §23311.  The basic effect of a suspension is to temporarily remove a corporation’s “powers, rights, and privileges.”  One such power is the power to sue and be sued.  Timberline v. Jaisinghani, 54 Cal. App. 4th 1361 (1997).  A suspension under California law does not entirely kill a corporation, however.  It sends it to the bardo where it can potentially be reborn through a certificate of revivor.  Id.  Once revived, a corporation regains its capacity to sue and be sued and that can sometimes be applied retroactively.  See Benton v. County of Napa, 226 Cal. App. 3d 1485, 1490 (Cal. Ct. App. 1991) (The revival of corporate powers validates any procedural step taken on behalf of the corporation while it was under suspension but does not eliminate any substantive defenses to the lawsuit that accrued after the case was filed). 

Enough with the law.  Let’s look at the facts.

Facts
In 2007, XC Foundation was incorporated under California law.

In 2008 the IRS officially gave it §501(c)(3) status.

In December 2020, the California Franchise Tax Board (FTB) suspended XC Foundation’s corporate rights and powers.  We don't know why, although such suspensions are often the result of a corporation failing to make the proper reports or pay their proper taxes.

In March 2021 the IRS revoked XC’s §501(c)(3) status on the basis of alleged self-dealing by two of its officers between 2016 and 2020.  The IRS also issued NODs to the two officers, hitting them with excise taxes under §4941 for the alleged self-dealing.  The two officers filed timely Tax Court petitions.  In May 2021 a petition was filed (note the passive voice!) seeking a declaratory judgment that the IRS’s revocation was wrong and also seeking to consolidate the XC Foundation case with the two officers’ cases.

In July 2022 the IRS moved to dismiss the XC Foundation case for lack of jurisdiction because XC’s suspension by the FTB meant it did not have the capacity to file a Tax Court petition.  It  was in legal bardo.

Judge Lauber agreed, giving us our lesson.

Lesson: Suspended Corporation Lacks Capacity To File Tax Court Petition
Judge Lauber gives the simple and straightforward analysis.  “Petitioner’s corporate powers and privileges were...suspended when it filed the petition and during the entire 90-day period in which its petition was required to be filed. Petitioner was thus incapable of initiating or prosecuting a case in this Court.”  Id. at 4.

The lawyer for XC Foundation made the kind of argument you would expect from someone in the bardo, unwilling to accept the situation.  It seems XC Foundation had, while fully alive and before the California FTB had suspended its powers, signed a Form 872 consent to extend the assessment period.  In a flurry of magical thinking worthy of the novel’s main characters, the taxpayer’s attorney argued that signing the consent somehow extended the corporation’s ability to contest the resulting decision letter even after corporate death, because of this language in Form 872: “signing this consent will not deprive the taxpayer(s) any an appeal rights to which they would otherwise be entitled.” 

Judge Lauber patiently explains that even if that language were read broadly to include Tax Court petitions, “a corporation whose powers have been suspended under State law is not “entitled” to commence litigation in this Court.” Op. at 5.  They are in the bardo.  Besides, parties to Tax Court litigation cannot magically create capacity when none exists.  Id. That’s the role of state law.

Bottom line: before you attempt to petition Tax Court on behalf of your corporate client, be sure they are still alive!  If they are not, get them revived under state law either before you file the petition or within the relevant petition period (e.g. 90 days of the NOL date if it's a deficiency proceeding).  Don't rely on the "reasonable time...after objection" language in Rule 60.  If you do, your case might become another Lesson From the Tax Court!

Comment 1: Certificate of Revivor?  A suspension under California law does not entirely kill a corporation.  It retains enough legal life to ask the California Franchise Tax Board (FTB) for a certificate of revivor.  Generally, the FTB does so only when the corporation deals with the reasons for the suspension.  The usual cause for a FTB suspension is a failure to file returns or pay applicable taxes, and California courts routinely recognize that the purpose of the suspension process is to get corporations to pay their taxes.  Timberline, supra.

A certificate of revivor would not help here, however.  Such a certificate will not apply retroactively if doing so prejudices a substantive defense accrued during the corporation’s suspension.  One substantive defense is the running of the relevant statute of limitation (SOL) after the filing date but before the revival date.  In those situations, California courts refuse to apply the revival retroactively to cure the SOL problem.  See discussion in Bourhis v. Lord, 295 P.3d 895 (2013) (revival cannot defeat a properly raised SOL defense).

The Tax Court has consistently followed the same rule: if a suspended corporation files a Tax Court petition, a revival of its corporate charter after the applicable petition period (generally 90 days) has run cannot cure the original jurisdictional defect of capacity.  For The Princess Bride analogy on this topic, see Lesson From The Tax Court: Mostly Dead Corporation Cannot File Petition, TaxProf Blog (May 20, 2019) (certificate of revival obtained later than 90 days after the NOD date was ineffective to create retroactive deficiency jurisdiction).

Comment 2: Consolidate in Federal District Court?  The taxpayers here (the two officers and the corporation) wanted to consolidate all three cases into one proceeding.  You can see why.  The basis for the assessment of excise taxes against the officers involved the same issues as the decision to revoke the corporate 501(c)(3) status, so it would be most efficient to litigate all three cases together.  One might wonder, therefore, why the taxpayers chose the Tax Court route and did not attempt to go the refund route in district court (for the two officers) and have the corporation file a Complaint in federal district court.  Recall §7428  permits a corporation to obtain judicial review in almost any federal court.  The excise taxes under §4941 appear to fit the definition of divisible taxes so the individuals would not need to pay the entire amount asserted against them but could instead pay just a portion.  But that path may not have been any better.  Section 7428 imposes a 90-day window to file the appropriate pleading in the chosen court.  The basic problem here would remain: XC Corporation was still in the bardo for that entire time. 

Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law.  He invites readers to return each Monday (or Tuesday if Monday is a federal holiday) to TaxProf Blog for another Lesson From The Tax Court.