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School Street Associates Limited Partnership v. District of Columbia

February 25, 1999


Before Steadman and Reid, Associate Judges, and Pryor, Senior Judge.

Notice: This opinion is subject to formal revision before publication in the Atlantic and Maryland Reporters. Users are requested to notify the Clerk of the Court of any formal errors so that corrections may be made before the bound volumes go to press.

Appeal from the Superior Court of the District of Columbia

(Hon. Kaye K. Christian, Trial Judge)

Argued November 16, 199

Steadman, Associate Judge: Appellant School Street Associates ("School Street") is a limited partnership investing in District real estate. *fn1 In contrast to federal law, such partnerships are taxed on their income in the District as distinct taxable entities. In this appeal, we are called upon to determine whether School Street is entitled to take the deduction provided in D.C. Code § 47-1803.3(a)(14) (1996). This code section in general allows a deduction for a net operating loss (NOL) that may be taken in a year prior to or subsequent to the year the loss was actually realized. *fn2 We hold that School Street, as an "unincorporated business," is entitled to the benefit of the deduction by a straightforward reading of the statute itself in light of the overall structure of District tax law. *fn3

I. Background

A. Overview of Tax Structure

To understand the provision of the District tax code at issue, it may be useful to establish a sense of the District tax code's overall structure and its contrast to the federal tax structure. Individuals, corporations, and unincorporated businesses are all separately subject to taxation under Title 47, Chapter 18 of the D.C. Code. A corporation includes trusts, associations, and companies that are classified as corporations under the federal Internal Revenue Code, and also includes financial institutions. D.C. Code §§ 47-1801.4(16), -1807.1(1) (1996). An unincorporated business is sweepingly defined as any trade or business conducted or engaged in by any non-corporate entity, with four express exceptions. D.C. Code § 47-1808.1 (1996). The most significant are the exceptions for a trade or business in which more than 80% of the gross income is derived from personal services and in which capital is not material, and for "professional corporations" under D.C. Code § 29-601 et seq. (1996), such as law firms, accounting firms, engineers, and medical practitioners. Such excepted trades or businesses are treated as "pass-through" entities. "Pass-through" enterprises are those for which losses or gains are not recognized by the entities themselves, but are allocated to the incomes of the organizations' owners in their capacity as individual taxpayers.

By comparison, the federal Internal Revenue Code of 1986 ("IRC") defines income tax in Subtitle A, Chapter 1, Subchapter A, which establishes a separate tax for individuals (Part I) and for corporations (Part II). 26 U.S.C.A. §§ 1, 11 (1998). How other structures will be treated within this essential framework is addressed elsewhere throughout the IRC. Most relevantly, Subchapter K, which covers partnerships, indicates that businesses taking this form are treated as pass-through entities for their principals. 26 U.S.C.A. §§ 701-02 (1998). These partnerships nonetheless file informational returns under the IRC indicating business performance. 26 U.S.C.A. § 6031(a) (1998).

In the District, individuals are taxed on personal income, while all taxable business entities are levied a franchise tax against the entity's income "for the privilege of carrying on or engaging in any trade or business within the District." D.C. Code §§ 47-1807.2(a), -1808.3(a) (1996). "Income" for all categories of taxpayers is defined in detail in subchapter III. Subchapter VII establishes the franchise tax for corporations and financial institutions; subchapter VIII establishes the franchise tax on unincorporated businesses. Subchapters VII and VIII are in many respects parallel, and both indirectly refer to subchapter III for a definition of taxable income. *fn4 D.C. Code §§ 47-1807.1(2), -1808.2(1) (1996). To avoid double taxation for unincorporated business activity, "the distributive share of a trade or business net income that is subject to the unincorporated business franchise tax" is excluded from calculation of an individual owner's gross income. D.C. Code § 47-1803.2(a)(2)(D) (1996). The structure of a business in the District, incorporated or unincorporated, typically will not have significant local tax consequences insofar as the business itself is concerned because both classifications are treated similarly by the District tax code. Regulations support this intent, explaining that

"the design of the unincorporated business tax under the law is to impose a tax upon all business income which would be subject to the corporation franchise tax (as though the business were incorporated), without regard to whether the business is carried on by an individual, a partnership, or some other unincorporated entity." 9 DCMR § 117.1 (1996).

Prior to 1987, no business, whether incorporated or not, could take advantage for District tax purposes of a net operating loss in one year by applying it against profits in another year. However, in 1987, in an effort to bring the District tax law into greater conformity with the IRC without any overall increase in District taxes, the D.C. Council enacted the Tax Conformity and Revision Amendment Act ("the Act"). Among its other numerous provisions, that Act added to the list of income deductions set forth in D.C. Code § 47-1803.3(a) the following new deduction:

"(14) Net operating losses. -- In computing the net income of a corporation, an unincorporated business, or a financial institution, there shall be allowed a deduction for net operating losses, in the same manner as allowed under § 172 of the Internal Revenue Code of 1986 and as reported on any federal tax return for the same taxable period."

The interpretation of D.C. Code ยง 47-1803.3(a)(14) (1996) and its interaction with the IRC is the issue debated by the parties and now ...

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