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IOWA SUPREME COURT: PARTNERSHIP INTERESTS DON'T QUALIFY FOR LONG-TERM GAIN BREAK

March 25, 2008

Iowa has a special tax break for certain business interest sales. If you have held an interest in a business for 10 years and "materially participated" in the business for 10 years, you can exclude the gain on a sale of "substantially all" of the business assets, or business real estate, on your Iowa tax return.

Gaylin Ranniger practiced as a CPA for many years with his partner Morrie Heithoff. In 1992 he sold his 50-percent interest to his partner. He claimed the Iowa "10 and 10" exclusion on his tax return, and the Iowa Department of Revenue disagreed.

The Iowa Department of Revenue rules on the capital gain exclusion provide:

Capital gains from the sale of an ownership interest in a partnership, limited liability company or other entity are not eligible for the capital gain exclusion.

The Iowa Department of Revenue rules on the capital gain exclusion provide:

Capital gains from the sale of an ownership interest in a partnership, limited
liability company or other entity are not eligible for the capital gain exclusion.

Mr. Ranniger argued that the rule was unreasonable, but the Iowa Supreme Court upheld the Department of Revenue last week. The court also said that because Mr. Ranniger's sale only was of half the business, rather than "substantially all" of it, it wouldn't qualify even if partnership interest sales did qualify.

IMPLICATIONS

The case shows that the deck is stacked in the Department of Revenue's favor in court:

Our cases require that exclusions from taxation be “construed strictly against the taxpayer and liberally in favor of the taxing body.”

The Ranniger result isn't surprising given the facts in the case. The Department has been holding other cases in abeyance while awaiting the Ranniger decision. Some of the cases involve the Department's old interpretation of what "held for 10 years" means -- an interpretation based (and I'm not making this up) on a misreading of an out-of-context passage in an old "Master Tax Guide." For you lawyers out there, this is like basing an argument over Iowa statutes on a misunderstood quote from Black's Law Dictionary. The Legislature overturned their strange interpretation for sales after 2005; they now conform to federal holding period rules.

The Iowa Supreme Court says it will overturn a Department rule only if it is "...irrational, illogical, or wholly unjustifiable." The Court had little trouble overturning the state's system of taxing casinos under a similar standard. If the Department maintains its "Master Tax Guide" position on pre-2005 holding-period cases, we'll see whether the Court gives the Department of Revenue more deference than it gives the Legislature.

Cite; Ranniger vs. Iowa Department of Revenue and Finance, Sup. Ct. Iowa, No. 11 / 06-0761

Tags: iowa tax policy.