T.C. Memo. 2018-201



                         UNITED STATES TAX COURT



        RAGHUNATHAN SARMA AND GAILE SARMA, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 26318-16.                         Filed December 12, 2018.



      Charles E. Hodges II, Antoinette G. Ellison, and Aditya Shrivastava, for

petitioners.

      Leslie J. Spiegel and Craig Connell, for respondent.



                           MEMORANDUM OPINION


      GOEKE, Judge: This case is before us on the parties’ cross-motions to

dismiss for lack of jurisdiction following respondent’s issuance of an affected item
                                            -2-

[*2] notice of deficiency. The parties submitted a declaration of witnesses with

attached exhibits.1

                                       Background

      When the petition was filed, petitioner Raghunathan Sarma resided in

Florida. Petitioner Gaile Sarma had a mailing address in New Jersey; the record

does not provide her State of residence. During the years at issue petitioners were

married and filed joint tax returns. They divorced in 2005.

      The adjustments in the notice of deficiency arise from Raghunathan Sarma’s

participation in a tax shelter known as a “Family Office Customized partnership”

or “FOCus”, a transaction substantially similar to the transaction described in

Notice 2002-50, 2002-2 C.B. 98. Mr. Sarma implemented the FOCus tax shelter

through a series of transactions executed by a three-tiered set of limited liability

companies treated as partnerships for Federal tax purposes:2 the upper tier

partnership, Nebraska Partners Fund, LLC (Nebraska Partners or Nebraska), the

middle-tier partnership, Lincoln Partners Fund, LLC (Lincoln Partners or



      1
        Respondent disputes that the declaration and exhibits submitted by
petitioners allow us to grant petitioners’ motion to dismiss. We will deny
petitioners’ motion and do not need to address the factual disputes. In response to
respondent’s motion, petitioners state that the material facts are not in dispute.
      2
          For simplicity, we refer to the entities as partnerships.
                                         -3-

[*3] Lincoln), and the lower tier partnership, Kearney Partners Fund, LLC

(Kearney Partners or Kearney). The tax shelter resulted in a series of deemed

terminations of the partnerships and deemed formations of new partnerships

because of changes in the ownership of the partnerships, including Mr. Sarma’s

purchases of Lincoln Partners and Nebraska Partners. Because of the deemed

terminations, the partnerships filed tax returns for multiple short tax periods

during 2001. Lincoln and Kearney were subject to the unified partnership audit

and litigation procedures (TEFRA) under sections 6221 through 6234 for short tax

periods (TEFRA tax periods) when Mr. Sarma did not formally own direct

interests in the partnerships.3 He was an indirect partner in both partnerships

during certain TEFRA tax periods. Of significance, Lincoln Partners was not

subject to TEFRA for the short tax period that Mr. Sarma held a direct interest in it

because it fell within the small partnership exception to TEFRA under section

6231(a)(1)(B) (small partnership tax period) and did not elect to be subject to

TEFRA.




      3
       Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the years at issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure. All amounts are rounded to the
nearest dollar.
                                         -4-

[*4] The issues for consideration are: (1) whether respondent is bound by an

initial decision (later abandoned) to audit Lincoln Partners’ return for the small

partnership tax period under the TEFRA procedures; we hold he is not;

(2) whether the special statute of limitations rules for TEFRA partnerships under

section 6229 apply for petitioners’ 2001 tax year; we hold they do; (3) whether a

partner-level determination is required to adjust petitioners’ tax liabilities

following the decision in the TEFRA case; we hold it is; and (4) whether

respondent issued invalid multiple notices of deficiency; we hold he did not.

I.    Tax Shelter Transactions

      Nebraska Partners and Lincoln Partners were formed on October 17, 2001.

The date of Kearney Partners’ organization is not stated in the record. As of

December 4, 2001, as part of the structure of the FOCus tax shelter, Nebraska

Partners owned 99% of Lincoln Partners, and Lincoln Partners owned 99% of

Kearney Partners. Bricolage Capital Management Co., a C corporation, was a 1%

partner in Nebraska and Lincoln and the tax matters partner of each. Delta

Currency Management Co. was a 1% partner and the tax matters partner of

Kearney Partners. Each of the three partnerships filed a partnership tax return for

the short tax period of October 17 to November 20, 2001 (November 20, 2001, tax

period), before Mr. Sarma acquired an ownership interest in the partnerships.
                                         -5-

[*5] The tax shelter involved three transactions relating to ownership changes of

the partnerships within the tiered structure. On December 4, 2001, Mr. Sarma

purchased a 99% interest in Nebraska Partners. All three partnerships terminated

their tax periods on December 4, 2001, pursuant to section 708(b)(1)(B), for short

tax periods of November 21 to December 4, 2001 (December 4, 2001, tax period).

See sec. 1.708-1(b)(2), Income Tax Regs. (providing that a partnership and any

lower tier partnerships shall terminate when 50% or more of the total interest in

the partnership’s capital and profits is sold or exchanged within a 12-month

period). New partnerships were deemed to be formed for the three partnerships,

and the partnerships treated their new tax periods as beginning on December 5,

2001.4 See 

(providing that when a partnership is deemed to

terminate by a sale or exchange of an interest, the partnership is deemed to

contribute its assets and liabilities to a new partnership in exchange for an interest

in the new partnership, and the terminated partnership is deemed to distribute

interests in the new partnership to the purchasing partner and other remaining

partners in liquidation of the terminated partnership). Each of the three




      4
      Respondent did not contest the December 5, 2001, date used for the
beginning of the partnerships’ tax periods.
                                        -6-

[*6] partnerships filed a partnership tax return for the December 4, 2001, tax

period on the basis of its deemed termination.

      On December 14, 2001, Mr. Sarma purchased a 99% interest in Lincoln

Partners from Nebraska Partners; Mr. Sarma already indirectly owned Lincoln

Partners through Nebraska Partners. Mr. Sarma directly held the partnership

interest in Lincoln Partners for the remainder of 2001. On December 14, 2001,

Lincoln and Kearney terminated their tax periods pursuant to section 708(b)(1)(B)

on the basis of Mr. Sarma’s purchase of Lincoln Partners, and two new

partnerships were deemed to be organized. See sec. 1.708-1(b)(4), Income Tax

Regs. Both Lincoln and Kearney reported short tax periods of December 5 to 14,

2001 (December 14, 2001, tax period). On December 19, 2001, Lincoln Partners,

with Mr. Sarma as a 99% partner, sold its 99% interest in Kearney Partners for

$737,118 to Fermium II Partners Fund, LLC, an entity related to the tax shelter

promoter. As a result of the sale, Kearney Partners terminated its tax period,

reporting a short tax period of December 15 to 19, 2001 (December 19, 2001, tax

period). Lincoln Partners filed a partnership return for the short tax period of

December 15 to 31, 2001 (December 31, 2001, tax period), and continued to file

returns for 2002 through 2004 with Mr. Sarma as its partner.
                                         -7-

[*7] Beginning before December 4, 2001, the date Mr. Sarma purchased his

Nebraska partnership interest, through December 19, 2001, the date Lincoln sold

its Kearney Partners interest, Kearney Partners executed offsetting foreign

currency options (FX straddles) generating significant artificial gains and losses.

At the time of Lincoln’s sale of its Kearney partnership interest, Kearney Partners

held $737,118 in cash and certificates of deposit totaling $81,794,837.5 It had

unrealized losses from the FX straddles that had not been closed out, but it also

had realized gain from the FX straddles. Lincoln Partners claimed that it had an

outside basis in its Kearney partnership interest at the time of the sale of

$79,110,062 on the basis of the gain from the FX straddles. It did not account for

the unrealized losses, however. Lincoln Partners reported a short-term capital loss

of $78,392,194 on the sale of its Kearney partnership interest (Lincoln loss) for its

December 31, 2001, tax period. It allocated $77,608,272 of the Lincoln loss to

Mr. Sarma as its 99% partner (Sarma loss). Petitioners claimed a deduction for the

Sarma loss on their 2001 joint tax return and carried forward portions of the loss to

2002 through 2004.


      5
        Kearney Partners retained the certificates of deposit and cash when
Lincoln sold its Kearney partnership interest. Mr. Sarma did not receive any
distributions from Kearney Partners upon Lincoln’s sale of the Kearney
partnership interest.
                                        -8-

[*8] On the basis of the above transactions, Lincoln Partners filed partnership tax

returns for the following three short tax periods during which Mr. Sarma owned an

indirect or direct interest: (1) the December 4, 2001, tax period, (2) the December

14, 2001, tax period, and (3) the December 31, 2001, tax period. Lincoln Partners

was subject to TEFRA for the first two tax periods, December 4 and 14, 2001. For

a portion of Lincoln’s December 31, 2001, tax period, from December 15 to 19,

2001, Lincoln was a 99% partner of Kearney, and Kearney was subject to TEFRA

during that time. Lincoln was a small partnership exempt from TEFRA for its

December 31, 2001, tax period, the only tax period that Mr. Sarma was a direct

partner. Lincoln Partners’ return for its December 31, 2001, tax period (December

31, 2001, return) shows that it had two partners and neither partner was the type

that would cause TEFRA to automatically apply. Lincoln did not attach a

statement to its December 31, 2001, tax return electing to opt out of the small

partnership exception and to apply TEFRA. See sec. 301.6231(a)(1)-1(b)(2),

Proced. & Admin. Regs. (a small partnership may elect to apply TEFRA by filing

an attachment to its return). On its December 31, 2001 tax return, Lincoln

Partners answered “yes” on line 4 of Schedule B to the question of whether it was

subject to TEFRA and named a tax matters partner.
                                        -9-

[*9] During Lincoln’s December 31, 2001 tax period, Mr. Sarma contributed

$36.5 million in cash to Lincoln Partners. The record does not establish whether

the contribution occurred before or after Lincoln sold its interest in Kearney

Partners. However, Mr. Sarma’s outside basis in Lincoln is not at issue here. Mr.

Sarma also guaranteed a $38.8 million loan used to execute the FX straddles. The

lender did not require the guaranty from Mr. Sarma as the FX straddles did not

result in any risk to the lender. Kearney Partners Fund, LLC ex rel. Lincoln

Partners Fund v. United States (Kearney), No. 2:10-cv-153-FtM-37CM, 

, at *9 (M.D. Fla. Mar. 7, 2014), aff’d per curiam, 

(11th Cir.

2015).

II.   Procedural History

      In May 2003 the Internal Revenue Service (IRS) began an examination of

petitioners’ 2001 return. Revenue Agent Barbara Rickard issued notices of

beginning of administrative proceeding (NBAP) dated June 6, 2003, to the three

partnerships for the following 10 tax periods:
                                      - 10 -

[*10]           Partnership                     Tax period

           Nebraska Partners                   Nov. 20, 2001
                                               Dec. 4, 2001
           Lincoln Partners                    Nov. 20, 2001
                                               Dec. 4, 2001
                                               Dec. 14, 2001
           Kearney Partners                    Nov. 20, 2001
                                               Dec. 4, 2001
                                               Dec. 14, 2001
                                               Dec. 19, 2001
                                               Dec. 31, 2001

        Subsequently, Revenue Agent Rickard issued NBAPs dated April 6 and

March 10, 2004, for Nebraska Partners’ and Lincoln Partners’ December 31, 2001,

tax periods, respectively. Respondent did not issue the NBAPs to Mr. Sarma. Mr.

Sarma was not a notice partner to whom respondent was required to issue an

NBAP. See sec. 6223(a) (requiring the Commissioner to issue notice partners

notices of the beginning and end of a partnership audit). In mid-2004 the

examination for the partnerships was transferred to Revenue Agent Linda Scheick.

In late 2004 she determined that neither Lincoln Partners nor Nebraska Partners

was subject to TEFRA for its December 31, 2001, tax period because both fell

within the small partnership exception and accordingly the NBAPs were issued in
                                        - 11 -

[*11] error. She did not solicit a written extension of the period of limitations for

Nebraska’s or Lincoln’s December 31, 2001, tax period.

      On July 31, 2009, respondent issued a notice of deficiency to petitioners for

2001 through 2004 (2009 notice), adjusting partnership and/or affected items of

the three partnerships relating to the partnerships’ November 20, 2001, tax periods

and items unrelated to any of the three partnerships. Respondent determined that

the three partnerships were shams and raised economic substance, step transaction,

substance over form, and other issues relating to the FOCus tax shelter. The

notice stated that it was for protective purposes in the event that the adjustments

were not subject to partnership-level proceedings under TEFRA. Petitioners filed

a petition with this Court and a motion to dismiss for lack of jurisdiction as to the

partnership and affected items on the basis that the partnerships were subject to

TEFRA. Respondent did not object to the motion but filed a response explaining

his position that the Court lacked jurisdiction over the partnership and affected

items. He asserted that both Lincoln Partners and Nebraska Partners were small

partnerships exempt from TEFRA for their December 31, 2001, tax periods.

Respondent’s Response to Petitioner’s Motion to Dismiss, Sarma v. Commissioner

(Sarma I), T.C. Dkt. No. 25694-09 (Nov. 16, 2012). Respondent identified the

Sarma loss as an affected item and asserted that Lincoln’s outside basis in its
                                        - 12 -

[*12] Kearney partnership interest is an affected item determined with reference to

the three partnerships’ TEFRA tax periods. The Court dismissed the partnership

and affected items on the basis of lack of jurisdiction in an order dated November

1, 2010. The parties settled the remaining adjustments. The November 16, 2012,

decision document included the following stipulation:

      Mr. Sarma does not concede that he has an interest in the outcome
      under I.R.C. § 6226(d) of any partnership proceedings involving
      Kearney, Lincoln, and Nebraska * * * or that any adjustment made to
      partnership items impacts the tax liabilities of Petitioners for tax years
      2001, 2002, 2003, and/or 2004.

      On December 9, 2009, respondent issued nine notices of final partnership

administrative adjustment (FPAAs) to Nebraska Partners, Lincoln Partners, and

Kearney Partners for their TEFRA tax periods for which the IRS had issued

NBAPs, see supra pp. 9-10, except that he did not issue FPAAs for Nebraska’s and

Lincoln’s small partnership tax periods, the December 31, 2001, tax periods. In

the FPAAs respondent determined that the three partnerships were disregarded for

tax purposes and reallocated their income, loss, and expenses to Mr. Sarma,

including those for their November 20, 2001, and December 4, 2001, tax periods

when Mr. Sarma was neither a direct nor indirect partner. He disallowed the

Lincoln loss on the basis that the partnerships were abusive tax shelters designed

to generate artificial tax losses. Mr. Sarma did not directly own any interest in the
                                        - 13 -

[*13] partnerships for the TEFRA tax periods. However, he did own indirect

interests for certain TEFRA tax periods.

      Respondent included a letter with the FPAAs mailed to Mr. Sarma stating

that he had the right to elect to have his partnership items treated as

nonpartnership items and thereby opt out of TEFRA under section 6223(e)

because of the IRS’ failure to timely issue NBAPs to him. See sec. 6223(d)

(requiring the Commissioner to issue an NBAP at least 120 days before issuing an

FPAA) and (e) (providing the right to opt out of TEFRA for notice partners who

did not timely receive an NBAP). On January 23, 2010, Mr. Sarma filed an

election with the IRS opting out of TEFRA. Respondent in a letter dated February

25, 2010, stated that he had erred and Mr. Sarma did not have the right to opt out

of TEFRA because he did not have the right to receive an NBAP. On December 3,

2010, respondent issued a protective converted items notice of deficiency to

petitioners for 2001 through 2004 (2010 notice) because of Mr. Sarma’s attempted

election to opt out of TEFRA. The 2010 notice contained the same adjustments to

partnership and affected items as the 2009 notice but did not contain the

adjustments unrelated to the three partnerships. Respondent filed a motion to

dismiss for lack of jurisdiction, arguing petitioners did not have the right to opt out

of TEFRA. Petitioners argued that Mr. Sarma had the right to opt out and that the
                                        - 14 -

[*14] 2010 notice was invalid on different grounds. The Court granted

respondent’s motion to dismiss, noting the parties agreed that the notice was

invalid. Sarma v. Commissioner, T.C. Dkt. No. 5307-11 (Mar. 16, 2012).

      In response to the FPAAs the partnerships filed complaints in the U.S.

District Court for the Middle District of Florida, and their cases were consolidated.

The partnerships filed a motion to dismiss for lack of personal and subject matter

jurisdiction as to Mr. Sarma, arguing that he had the right to opt out of the TEFRA

proceedings because he did not timely receive an NBAP. Kearney, No. 2:10-cv-

153-FtM-SPC, 

(M.D. Fla. Mar. 27, 2013) (order). The District

Court denied the motion, holding that Mr. Sarma did not have a right to receive an

NBAP and therefore did not have the right to opt out of TEFRA. 

see sec.

6223(a); sec. 301.6223(c)-1, Proced. & Admin. Regs. (providing manner for

partners to become notice partners).

      Following a bench trial the District Court upheld the disallowance of the

Lincoln loss deduction but held that the plaintiffs were not subject to a section

6662(a) accuracy-related penalty on the basis of Mr. Sarma’s participation in the

voluntary disclosure program described in Notice 2002-2, 2002-1 C.B. 304.

Kearney, No 2:10-cv-153-FtM-SPC, 

(M.D. Fla. Mar. 7, 2014).

The District Court found that Mr. Sarma “schemed to create and operate the
                                        - 15 -

[*15] partnerships (even before Mr. Sarma formally purchased them) to serve as

an abusive tax shelter”. 

The District Court held: “The FPAAs properly

found that the partnerships lacked economic substance and made adjustments

accordingly”. 

It found that every step of the FOCus tax shelter,

including the creation of the partnerships, the FX straddles, Mr. Sarma’s purchase

of Nebraska and Lincoln, the capital contributions, the guaranty, and the sale of

Kearney, was “solely motivated by tax-avoidance.”6 

It found that “the

transactions at issue lacked both economic effects and a legitimate business

purpose and thus are not entitled to tax respect.” 

Court entered a judgment “in favor of Defendant and against

Plaintiffs as to the lack of economic substance of the partnerships and adjustments

in the FPAAs”, holding that the FPAA adjustments that reallocated income and/or

loss to Mr. Sarma in his individual capacity were moot and not upheld. The

District Court did not make a finding with respect to Lincoln Partners’ outside

basis in its Kearney partnership interest. The U.S. Court of Appeals for the

Eleventh Circuit affirmed the decision on October 13, 2015. Kearney, 

.

        6
       The District Court erroneously stated that Mr. Sarma, rather than Lincoln
Partners, sold the 99% interest in Kearney Partners. We find this error is
immaterial to our decision.
                                        - 16 -

[*16] On September 9, 2016, respondent issued an affected items notice of

deficiency (2016 notice) to petitioners for 2001 through 2004. The adjustments in

the 2016 notice arise from Mr. Sarma’s participation in the FOCus tax shelter. In

the notice respondent disallowed the deduction of petitioners’ share of the

Lincoln loss on the sale of the Kearney partnership interest, i.e., the Sarma loss,

for 2001 and the capital loss carryforwards for 2002 through 2004 on the basis that

Kearney Partners and Lincoln Partners were shams and disregarded for tax

purposes. The disallowance of the Sarma loss deduction was the only adjustment

except for adjustments to itemized deductions on the basis of statutory limitations

as a result of the loss deduction disallowance. On December 14, 2016, respondent

assessed the tax against petitioners with respect to the adjustments asserted in the

2016 notice and issued a notice of computational adjustment for each year. He

issued the 2016 notice for protective purposes.

III.   Nebraska Partners

       Nebraska Partners filed a partnership tax return for the short tax period

December 5 to 31, 2001, during which it was a small partnership exempt from

TEFRA. Mr. Sarma directly owned the Nebraska partnership interest from

December 5 to 31, 2001. Nebraska reported a capital loss of $77,613,999 from the

sale of its partnership interest in Lincoln Partners to Mr. Sarma (Nebraska loss) on
                                       - 17 -

[*17] December 14, 2001, and treated the loss deduction as disallowed under

section 707(b)(1). See sec. 707(b)(1) (providing that no loss deduction shall be

allowed from the sale of property between a partnership and a direct or indirect

partner owning more than a 50% capital or profits interest in the partnership). On

their 2001 joint tax return petitioners reported the Nebraska loss deduction as

disallowed. Treatment of the Nebraska loss is not at issue. Respondent did not

issue an FPAA to Nebraska Partners for the December 5 to 31, 2001, tax period.

                                    Discussion

      The parties agree that Lincoln Partners satisfied the definition of a small

partnership under section 6231(a)(1)(B) and was exempt from TEFRA for its

December 31, 2001, tax period, the period of 2001 during which Mr. Sarma was a

direct partner.7 Mr. Sarma was an indirect partner in Lincoln during its December

14, 2001, TEFRA tax period. See sec. 6231(a)(10) (defining an indirect partner as

a “person holding an interest in a partnership through 1 or more pass-through

      7
       A small partnership is defined as a partnership with 10 or fewer partners
who are individuals (other than nonresident aliens), C corporations, or estates of
deceased partners. Sec. 6231(a)(1)(B)(i). A partnership’s status as a small
partnership is determined annually “with respect to each partnership taxable year.”
Sec. 301.6231(a)(1)-1(a)(3), Proced. & Admin. Regs. A partnership cannot
qualify as a small partnership if any partner is a passthrough partner. 

A passthrough partner is “a partnership, estate, trust, S corporation, nominee,
or other similar person through whom other persons hold an interest in the
partnership”. Sec. 6231(a)(9) (defining a passthrough partner).
                                        - 18 -

[*18] partners”). Lincoln Partners was a 99% partner of Kearney Partners for

Kearney’s December 19, 2001, TEFRA tax period, during which time Mr. Sarma

was an indirect partner in Lincoln and Kearney.

I.    Parties’ Arguments

      Petitioners make three arguments in support of their motion to dismiss.

They argue that the Court should dismiss this case whether we apply the TEFRA

procedures or the normal deficiency procedures of subchapter B of chapter 63 of

the Code. The first two arguments depend on whether TEFRA applies despite

Lincoln’s status as a small partnership for its December 31, 2001, tax period.

First, they argue that TEFRA applies for Lincoln’s December 31, 2001, tax period

because the IRS determined that TEFRA applied when it issued an NBAP and

respondent is bound by that determination. They argue that respondent failed to

issue the required FPAA, the 2016 notice is invalid, and the Court lacks

jurisdiction over this case. As an alternative argument, petitioners contend that if

we treat Lincoln Partners as a small partnership exempt from TEFRA, we must

also dismiss. They argue that if Lincoln is a small partnership for its December

31, 2001, tax period, the special statute of limitations rules applicable for TEFRA

partnerships under section 6229 likewise do not apply for the December 31, 2001,

tax period. They argue that the period of limitations is determined under section
                                       - 19 -

[*19] 6501 and expired no later than February 16, 2013, more than three years

before the 2016 notice was issued. Respondent counters that the adjustments

relate to partnership items from Kearney’s and Lincoln’s prior TEFRA tax periods

even though Lincoln was a small partnership exempt from TEFRA for its

December 31, 2001, tax period. Third, petitioners argue that if we find that the

statute of limitations does not bar assessment, the 2016 notice is invalid because

respondent previously issued two deficiency notices for 2001 through 2004.

      Respondent filed a cross-motion to dismiss, also arguing that the 2016

notice is invalid. He argues that the adjustments in the 2016 notice do not require

a partner-level determination and therefore are not subject to the deficiency

procedures. He argues that the partnership-level case determined that Kearney

Partners was a sham and thus Lincoln cannot have an outside basis in its Kearney

partnership interest in excess of zero, citing United States v. Woods, 

(2013). He argues that no partner-level determinations are required to adjust

Lincoln’s outside basis to zero because taxpayers cannot have basis in an asset that

does not exist for Federal tax purposes. According to respondent’s argument,

outside basis is always zero in a sham partnership and the adjustments at issue are

computational and do not require the issuance of deficiency notices. Accordingly,
                                       - 20 -

[*20] he argues that the 2016 notice is invalid and we do not have jurisdiction in

this case.

      This Court is a court of limited jurisdiction; we may exercise our

jurisdiction only to the extent provided by statute. See sec. 7442; GAF Corp. &

Subs. v. Commissioner, 

, 521 (2000). We have jurisdiction to

redetermine a deficiency if the Commissioner issues a valid notice of deficiency

and the taxpayer files a timely petition. GAF Corp. & Subs. v. Commissioner, 

.

II.   Application of TEFRA Procedures

      Both parties agree that Lincoln Partners was a small partnership exempt

from TEFRA for its December 31, 2001, tax period. However, petitioners argue

that the IRS determined (although erroneously) through the issuance of the NBAP

in December 2004 and the 2009 notice that TEFRA applied for Lincoln’s

December 31, 2001, tax period. They argue that respondent is bound by that

determination pursuant to section 6231(g)(1) and was required to issue an FPAA

for Lincoln’s December 31, 2001, tax period to make the adjustments he seeks in

this case. According to petitioners, respondent failed to issue an FPAA, and thus

the Court lacks jurisdiction over Lincoln’s December 31, 2001, tax period and

lacks jurisdiction to disallow the Sarma loss deduction. We find that neither the
                                       - 21 -

[*21] NBAP nor the 2009 notice constitutes a determination by respondent to treat

Lincoln Partners as a TEFRA partnership for its December 31, 2001, tax period.

For the reasons set forth below, we hold that respondent did not determine that

TEFRA applied for Lincoln’s December 31, 2001, tax period.

      Under section 6231(g)(1), when the Commissioner erroneously determines

that TEFRA applies to a non-TEFRA partnership, the partnership will be subject

to TEFRA so long as that determination was reasonable on the basis of the

partnership’s tax return. When the Commissioner makes a reasonable but

erroneous determination on the basis of a partnership return that TEFRA applies to

a small partnership, a partnership that should be subject to the normal deficiency

procedures will instead be subject to the TEFRA procedures. Conversely, TEFRA

will not apply to a TEFRA partnership where the Commissioner has reasonably

but erroneously determined on the basis of a partnership return that TEFRA does

not apply. Sec. 6231(g)(2). Respondent maintains that he did not determine that

TEFRA applied for Lincoln’s December 31, 2001, tax period, and if the Court

finds that he made such a determination, that determination was not reasonable

because Lincoln Partners’ December 31, 2001, tax return clearly shows that it was

a small partnership and Lincoln did not file an attachment to the return electing to

have TEFRA apply.
                                         - 22 -

[*22] Section 6231(g)(1) was intended to protect the Commissioner where he

makes an erroneous determination on the basis of a partnership return that a small

partnership is subject to TEFRA so long as his determination was reasonable.

Bedrosian v. Commissioner, 

, 104-105 (2014). It is a relief provision

for the IRS. The Code grants this relief because of the difficulty that the IRS may

have when determining whether a partnership is subject to TEFRA. 

Congress’ purpose for enacting section 6231(g) was “to simplify the IRS’ task of

choosing between the TEFRA procedures and the normal deficiency procedures

by permitting the IRS to rely on the partnership’s return.” 

attempt to use section 6231(g)(1) as a punitive measure against

respondent on the basis of certain statements on Lincoln’s December 31, 2001,

return that conflict with its small partnership status.

      On Lincoln’s December 31, 2001, return it answered “yes” to question 4

asking whether TEFRA applied, and it named a tax matters partner. The return

shows that the partnership had two partners and that neither partner was the type

of partner that would cause TEFRA to automatically apply. See sec.

6231(a)(1)(B)(i) (setting forth the criteria for a small partnership). Notably,

Lincoln Partners did not follow the rules set forth in the regulations or the 2001

Instructions for Form 1065, U.S. Partnership Return, which state: “Caution! This
                                        - 23 -

[*23] partnership does not make this election when it answers Yes to Question 4.

The election must be made separately.” Lincoln did not attach a statement to its

December 31, 2001, return to elect to have TEFRA apply as required by the

regulations or Form 1065 Instructions. See sec. 6231(a)(1)(B)(ii); sec.

301.6231(a)(1)-1(b)(2), Proced. & Admin. Regs. (the method for a small

partnership to elect to apply TEFRA is to attach a statement to its return).

      If section 6231(g)(1) applies, it would render Lincoln Partners subject to

TEFRA for the December 31, 2001, tax period even though the parties agree that it

fell within the small partnership exception. For section 6231(g)(1) to apply, three

events must occur: (1) the IRS determined on the basis of Lincoln Partners’ return

that it was subject to TEFRA, (2) the determination was erroneous, and (3) the

determination was reasonable. When the Commissioner issues multiple notices

with conflicting determinations regarding TEFRA’s applicability, the first notice

controls. Bedrosian v. Commissioner, 

(the Commissioner issued

an FPAA followed by a notice of deficiency). We conclude infra that respondent

did not determine that TEFRA applied for Lincoln’s December 31, 2001, tax

period. The second factor is not at issue; the parties agree that such a
                                        - 24 -

[*24] determination would have been erroneous because Lincoln was a small

partnership for its December 31, 2001, tax period.8

      In considering the first factor we must address a threshold question of

whether the IRS made a determination that TEFRA applies, and a secondary

question of what type of notice from the IRS constitutes a determination.

Petitioners argue that the 2009 notice and the NBAP constitute a determination by

respondent. We disagree. The 2009 notice is not a determination for purposes of

section 6231(g). For section 6231(g) to apply, the Commissioner must make a

single partnershipwide determination regarding TEFRA’s applicability. Bedrosian

v. Commissioner, 

. In the 2009 notice respondent determined that

petitioners were not entitled to deduct the portion of the Lincoln loss allocated to

Mr. Sarma. Respondent did not make a partnershipwide determination and

accordingly did not make a determination regarding TEFRA’s applicability for

purposes of section 6231(g). As the 2009 notice was not a partnershipwide

adjustment, the notice does not constitute a determination under section 6231(g).

      Even if the 2009 notice made partnershipwide adjustments, the notice could

not constitute a determination because it was invalid as to the adjustments relating

      8
      As we find that respondent did not determine that TEFRA applied for
Lincoln’s December 31, 2001, tax period, we do not consider whether such a
determination would have been reasonable, the third factor.
                                         - 25 -

[*25] to the partnership and affected items. We dismissed the partnership and

affected items in Sarma I. Petitioners argue that the dismissal in Sarma I is

consistent with a determination that TEFRA applied for Lincoln’s December 31,

2001, tax period. They characterize the decision in Sarma I as finding that Mr.

Sarma would not have affected items from Kearney and Kearney cannot affect

their 2001 tax liability. However, our decision to dismiss with respect to the

partnership and affected items did not result from a finding that Lincoln’s

December 31, 2001, tax period was subject to TEFRA. While petitioners argued

for dismissal in Sarma I as to the partnership and affected items adjustments,

respondent issued the 2009 notice with respect to these adjustments for protective

purposes. In Sarma I respondent stated to the Court that Lincoln was a small

partnership for its December 31, 2001, tax period and the three partnerships were

subject to TEFRA for “certain” tax periods during 2001 in clear contradiction to

petitioners’ characterization of that case. Respondent did not take the position that

TEFRA applied for Lincoln’s December 31, 2001, tax period. Rather, the decision

in Sarma I is consistent with a determination that Lincoln is not subject to TEFRA

for its December 31, 2001, tax period.

      Nor does the NBAP constitute a determination by the Commissioner that

TEFRA applies for purposes of section 6231(g). The Commissioner makes a
                                       - 26 -

[*26] determination when he issues the notice that concludes the examination.

Bedrosian v. Commissioner, 

. We have held that an FPAA is

the Commissioner’s determination of TEFRA’s applicability; inherent in the

issuance of an FPAA is a determination that TEFRA applies. 

see

Clovis I v. Commissioner, 

, 982 (1987). Respondent did not issue an

FPAA for Lincoln’s December 31, 2001, tax period. Accordingly, he did not

make a determination that TEFRA applied for that tax period. See Bedrosian v.

Commissioner, 

(events occurring during the examination are

not determinative as to whether TEFRA applies). Furthermore, nothing in the

Code nor the regulations requires the Commissioner to make an adjustment or

issue a notice following the conclusion of an audit. See sec. 6223 (relating to

issuance of notices at beginning and conclusion of partnership audit). We hold

that section 6231(g) does not apply, and Lincoln’s December 31, 2001, tax period

is not subject to TEFRA.

      Petitioners also argue that the NBAP should control because Mr. Sarma did

not receive notice at the end of Lincoln’s audit that TEFRA did not apply for

Lincoln’s December 31, 2001, tax period. They argue that they reasonably relied

on the NBAP and reasonably expected respondent to issue an FPAA. They argue

that respondent had a duty to inform them that he would not issue an FPAA and
                                         - 27 -

[*27] did not notify them that one would not be issued. They argue that the

issuance of the NBAP should control because the Commissioner must determine

whether to apply TEFRA or the normal deficiency procedures at the beginning of

a partnership audit. They emphasize the importance of the beginning of the audit

because, they argue, if TEFRA does not apply, the Commissioner must deal

directly with each partner during the audit rather than the TEFRA tax matters

partner. They rely on a statement in Harrell v. Commissioner, 

, 246

(1988), that a determination “should be made by respondent as of the date of

commencement of the audit of the partnership (but not necessarily on that date) by

examining the partnership return * * * prior to this date.” Harrell does not support

petitioners’ argument that the Commissioner must definitively determine

TEFRA’s applicability at the beginning of the audit or that a revenue agent’s

initial decision to issue an NBAP controls. It was not reasonable for Mr. Sarma to

expect respondent to issue an FPAA for Lincoln’s December 31, 2001, tax period

as its status as a small partnership is clear on the partnership return and it did not

file the required attachment to make an election.

      Moreover, respondent did not have a duty to inform petitioners that he

would not issue an FPAA. Petitioners do not cite any authority in the Code or the

regulations to support their argument that respondent had such a duty. There is no
                                       - 28 -

[*28] basis to impose a duty on respondent to inform petitioners that he would not

issue an FPAA. In Sarma I respondent stated that Lincoln was a small partnership

for the December 31, 2001, tax period, so petitioners should have known no FPAA

would be issued. Revenue Agent Rickard issued an NBAP for Lincoln’s

December 31, 2001, tax period and information document requests to Lincoln’s

tax matters partner. In mid-2004 the examination of the partnerships’ and

petitioners’ returns was transferred to Revenue Agent Scheick, and she determined

that TEFRA did not apply for that tax period. She began treating Lincoln Partners

as a non-TEFRA partnership for its December 31, 2001, tax period approximately

one year after the NBAP for Lincoln was issued and approximately five years

before the 2009 notice and the FPAAs for the TEFRA tax periods were issued.

Under these facts any expectation on Mr. Sarma’s part that respondent would issue

an FPAA for Lincoln’s December 31, 2001, tax period would not have been

reasonable.

      In summary, respondent was not required to issue an FPAA for Lincoln’s

December 31, 2001, tax period to make the adjustments he seeks in this case. We

will deny petitioners’ motion to dismiss with respect to this argument.
                                        - 29 -

[*29] III.   Application of Section 6229 Special Statute of Limitations Rules

      As we have found that respondent was not required to issue an FPAA for

Lincoln’s December 31, 2001, tax period, we next consider petitioners’ argument

that the statute of limitations under section 6501 bars assessment. The statute of

limitations is an affirmative defense and does not raise a jurisdictional issue. See

sec. 6213(a) (our jurisdiction to redetermine a deficiency depends on the issuance

of a notice of deficiency and filing of a petition); Davenport Recycling Assocs. v.

Commissioner, 

, 1259 (11th Cir. 2000), aff’g T.C. Memo. 1998-

347; Columbia Bldg., Ltd. v. Commissioner, 

, 611 (1992). Thus, the

Court would not lose jurisdiction even if petitioners are correct that the statute of

limitations bars assessment. As a result we will treat petitioners’ statute of

limitations argument as a motion for summary judgment. A motion for summary

judgment may be granted where the pleadings and other materials show that there

is no genuine issue as to any material fact and that a decision may be rendered as a

matter of law. Rule 121(b); Sundstrand Corp. v. Commissioner, 

, 520

(1992), aff’d, 

(7th Cir. 1994). The burden is on the moving party to

show that there is no genuine dispute of material fact and he is entitled to

judgment as a matter of law. FPL Grp., Inc. & Subs. v. Commissioner, 

, 74-75 (2001). In summary judgment cases the evidence is viewed in the light
                                        - 30 -

[*30] most favorable to the nonmoving party. Bond v. Commissioner, 

, 36 (1993).

      Section 6229 extends the period of limitations for assessment prescribed by

section 6501 with respect to partnership and affected items. See sec. 6501(n)(2);

Rhone-Poulenc Surfactants & Specialities, L.P. v. Commissioner, 

,

540-543 (2000). It applies to assessments of tax “with respect to any person

which is attributable to any partnership item (or affected item) for a partnership

taxable year.” Sec. 6229(a). Under section 6229(a) the period of limitations for

TEFRA partnerships is triggered by the later of (1) the filing of the partnership tax

return or (2) the last day for filing the return. The timely mailing of an FPAA

suspends the running of the limitations period for assessing any income tax that is

attributable to any partnership item or affected item. See sec. 6229(d). The

limitations period remains suspended for the period during which an action may be

filed in court, during the pendency of any proceeding actually brought, and for one

year thereafter. 

non-TEFRA small partnership, however, the limitations

period is generally triggered upon the filing of the partner’s return, not the

partnership return. Wolf v. Commissioner, 

, 714 (9th Cir. 1993), aff’g

T.C. Memo. 1991-212.
                                        - 31 -

[*31] Petitioners do not dispute that the period of limitations would remain open

if section 6229 applied. If section 6229 applied, the period of limitations for

assessments with respect to the Sarma loss would expire one year after the District

Court’s decision became final, January 11, 2017. Rather, they argue that section

6229 special statute of limitations rules for TEFRA partnerships cannot apply for a

small partnership exempt from TEFRA. They argue that section 6229 does not

apply for Lincoln’s December 31, 2001, tax period and the December 31, 2001,

tax period was the only tax period during which Mr. Sarma owned a direct interest

in Lincoln. They argue that the period of limitations under section 6501 has

expired. We hold that the special statute of limitations rules for TEFRA

partnerships under section 6229 apply for Lincoln’s non-TEFRA December 31,

2001, tax period and extend the period of limitations for petitioners’ 2001 tax year.

      By its terms, section 6229 applies only to partnership or affected items.

Petitioners argue that as a small partnership Lincoln Partners cannot have

partnership or affected items and thus section 6229 does not apply. They argue a

small partnership can have only nonpartnership items, citing Nehrlich v.

Commissioner, T.C. Memo. 2007-88, aff’d, 327 F. App’x 712 (9th Cir. 2009), and

Am. Milling, L.P. v. Commissioner, T.C. Memo 2015-192. According to

petitioners, the Lincoln loss was a nonpartnership item of a small partnership. In
                                         - 32 -

[*32] Nehrlich v. Commissioner, slip op. at 7, we wrote: “TEFRA then defines

‘partnership’ to exclude small partnerships * * * and this then excludes them from

TEFRA procedures because a small partnership would have only nonpartnership

items”. Petitioners argue that in Am. Milling, L.P. we held that TEFRA

partnerships have partnership items and by analogy a small partnership can have

only nonpartnership items.

      While petitioners may be correct that a small partnership may not have

partnership or affected items flowing from it, a small partnership can have affected

items from its participation in other TEFRA partnerships. A partnership item is

“any item required to be taken into account for the partnership’s taxable year

under any provision of Subtitle A [Income Taxes] to the extent [the] regulations

* * * provide that, for purposes of this subtitle, such item is more appropriately

determined at the partnership level than at the partner level.” Sec. 6231(a)(3). A

nonpartnership item is an “item which is (or treated as) not a partnership item.”

An affected item is any item to the extent it is affected by the

determination of a partnership item. 

Generally, outside basis is an

affected item. 

; Petaluma FX Partners, LLC v.

Commissioner, 

, 655 (D.C. Cir. 2010), aff’g in part, rev’g and

remanding in part 

(2008); see sec. 301.6231(a)(5)-1(b), Proced. &
                                        - 33 -

[*33] Admin. Regs. A computational adjustment is “the change in the tax liability

of a partner which properly reflects the treatment * * * of a partnership item. All

adjustments required to apply the results of a proceeding with respect to a

partnership * * * to an indirect partner shall be treated as computational

adjustments.” Sec. 6231(a)(6).

      Lincoln Partners was a TEFRA partnership and became a small partnership

exempt from TEFRA for a subsequent tax period, i.e., the December 31, 2001, tax

period. During the non-TEFRA small partnership tax period, Lincoln owned an

interest in a TEFRA partnership, Kearney Partners. Lincoln’s sale of the Kearney

partnership interest generated the Lincoln loss that passed through to Mr. Sarma as

Lincoln’s partner during Lincoln’s small partnership tax period. Lincoln’s outside

basis in Kearney is an affected item from the TEFRA partnership proceeding.

Lincoln Partners was a direct partner and Mr. Sarma was an indirect partner of

Kearney Partners during its TEFRA tax period, ending upon the sale of Lincoln’s

interest in Kearney, i.e., the December 19, 2001, TEFRA tax period. TEFRA

applies to any entity with respect to any taxable year that files a partnership return

and to any person holding an interest in such entity either directly or indirectly at

any time during that taxable year. Sec. 301.6233-1(a), Admin. & Proced. Regs.
                                        - 34 -

[*34] For purposes of TEFRA, an indirect partner is a partner.9 See sec.

6231(a)(9) (defining passthrough partner) and (10) (defining indirect partner). An

adjustment to an affected item from the TEFRA proceeding applies to an indirect

partner.

      Once a partnership item is determined the Commissioner may adjust items

attributable to the partnership items to determine and change a partner’s tax

liability attributable to the partnership items. The adjustments may occur in tax

periods following the periods at issue in the TEFRA proceeding. See Kligfeld

Holdings v. Commissioner, 

, 199-207 (2007). The adjustment to the

Lincoln loss, which passed through to Mr. Sarma (Sarma loss), resulted from the

Kearney TEFRA proceeding. Kearney’s December 19, 2001, TEFRA tax period

ended within Lincoln’s December 31, 2011, small partnership tax period and

petitioners’ 2001 tax year. Thus, the TEFRA decision enters into Lincoln’s

computation of its gain or loss on the sale of its Kearney partnership interest

during its December 31, 2001, tax period even though Lincoln was a small

partnership during that tax period and even though Lincoln’s December 31, 2001,

tax period was not at issue in Kearney. The fact that Lincoln was a small

      9
       A partner is defined as either (1) a partner in the partnership or (2) any
other person whose income tax liability is determined directly or indirectly by
taking partnership items into account. Sec. 6231(a)(2).
                                        - 35 -

[*35] partnership during the tax period in which it sustained the subject loss is not

relevant.

      Mr. Sarma was a partner in Lincoln during Kearney’s TEFRA tax period

when the Lincoln loss arose, the December 19, 2001, tax period, and over which

the District Court had jurisdiction. Accordingly, he was a person to which a

partnership item or an affected item was attributable. Thus, the Kearney decision

can result in affected items to Mr. Sarma and may affect his 2001 tax liability.

Lincoln’s outside basis in Kearney Partners is an affected item. It affected the

amount of Lincoln’s loss on the sale of Kearney. The loss passed through to Mr.

Sarma as a partner in Lincoln, and he deducted his share of the Lincoln loss, i.e.,

the Sarma loss. The Sarma loss is attributable to the partnership items determined

in Kearney.

      Section 6229 extends the period of limitations for assessing tax attributable

to partnership items and affected items following the conclusion of a TEFRA

proceeding. It applies to determine the period of limitations to assess tax against

the partners attributable to the partnership items and affected items. Those

affected items arose in Lincoln’s December 31, 2001, tax period when it was a

small partnership. Accordingly, section 6229 can apply to a non-TEFRA small

partnership where the small partnership has affected items from a TEFRA
                                        - 36 -

[*36] proceeding. It extends the limitations period to assess tax attributable to the

affected items with respect to Mr. Sarma because he was an indirect partner in

Kearney Partners for the TEFRA tax periods irrespective of the fact that the loss

passed through to Mr. Sarma during Lincoln’s non-TEFRA tax period.

Accordingly, the period of limitations has not expired for petitioners’ 2001

through 2004 tax years with respect to the Sarma loss, and we will deny

petitioners’ motion with respect to their statute of limitations argument.

IV.   Partner-Level Determination

      We next address respondent’s motion to dismiss for lack of jurisdiction.

Under section 6226(f) a court’s jurisdiction in a TEFRA partnership-level

proceeding extends to all partnership items for the partnership taxable year to

which the FPAA relates, the proper allocation of the partnership items among the

partners, and the applicability of any penalty, addition to tax, or additional amount

that relates to an adjustment to a partnership item. Once the partnership-level

adjustments become final, the Commissioner must initiate further action at the

partner level to make any resulting adjustments to the tax liabilities of the

individual partners. The Commissioner must follow the deficiency notice

procedures under sections 6211 through 6216 for adjustments attributable to

affected items that require partner-level determinations. Sec. 6230(a)(2)(A)(i);
                                        - 37 -

[*37] sec. 301.6231(a)(6)-1(a)(3), Proced. & Admin. Regs. In such a case the

partner has a prepayment forum to challenge the Commissioner’s determination.

Sec. 6230(a)(2)(A)(i).

      The deficiency notice procedures do not apply to an adjustment to an

affected item that does not require a partner-level determination. 

If

no partner-level determination is required, the adjustment is computational and the

Commissioner can directly assess the resulting tax deficiency against each partner

without issuing a notice of deficiency. Id.; sec. 301.6231(a)(6)-1(a)(2), Proced. &

Admin. Regs. The partner would not have access to the deficiency procedures to

challenge the Commissioner’s computational adjustments. Instead, he must file a

claim for refund and rely on refund litigation if the refund claim is denied. See

sec. 6230(a)(1), (c)(4).

      Respondent moves for dismissal, arguing that the adjustments at issue are

computational and do not require any partner-level determinations on the basis of

the decision in Kearney that Kearney Partners was a sham for its December 19,

2001, tax period. He argues that Lincoln’s outside basis in the sham Kearney

partnership must be zero without any further partner-level determinations and thus

Lincoln could not have sustained a loss on the sale of its Kearney partnership

interest to pass through to Mr. Sarma. According to respondent, the deficiency
                                        - 38 -

[*38] procedures do not apply, the 2016 notice is invalid, and we should dismiss

on the basis of lack of jurisdiction. Respondent directly assessed tax against

petitioners attributable to the disallowance of the Sarma loss deduction and issued

the 2016 notice as a protective measure.

      Petitioners argue that outside basis must be determined at the partner level

and not assumed to be zero irrespective of the decision in a partnership-level case

that the partnership was a sham. They argue that a computational adjustment

means only an adjustment that can be made with a mathematical computation.

They also renew their argument that the Lincoln loss and its outside basis in

Kearney Partners are nonpartnership items on the basis that Lincoln cannot have

any affected items from TEFRA because Lincoln was a non-TEFRA small

partnership for its December 31, 2001, tax period. We have found that a small

partnership that owns an interest in a TEFRA partnership can have affected items

from the TEFRA partnership, and we will not revisit this argument. The issue is

whether a partner-level determination is required to adjust a purported partner’s

outside basis in a sham partnership to zero.

      A partner’s outside basis in his partnership interest is “an affected item to

the extent it is not a partnership item.” Sec. 301.6231(a)(5)-1(b), Proced. &
                                        - 39 -

[*39] Admin. Regs. Following disagreement among the Courts of Appeals,10 the

Supreme Court decided that a court in a partnership-level TEFRA proceeding has

jurisdiction to provisionally determine an accuracy-related penalty relating to the

portion of any underpayment that is attributable to a valuation misstatement of

outside basis. Woods, 

. The Supreme Court recognized that a

partner’s outside basis is a nonpartnership item that the courts do not have

jurisdiction to adjust in a TEFRA partnership-level proceeding. 

Outside

basis must be adjusted at the partner level. 

reasoned that “once

the partnerships were deemed not to exist for tax purposes, no partner could

legitimately claim an outside basis greater than zero”, 

and the court in a

partnership-level proceeding where the partners’ liability for a penalty is at issue is

“not required to shut its eyes to the legal impossibility of any partner’s possessing

an outside basis greater than zero in a partnership that, for tax purposes, did not

exist”, 

Thus, a court has jurisdiction to determine the penalty “even if

      10
         Thompson v. Commissioner, 

, 872 (8th Cir. 2013), rev’g and
remanding 

(2011); Jade Trading, LLC v. United States, 

, 1380 (Fed. Cir. 2010); Petaluma FX Partners, LLC v. Commissioner, 

, 655 (D.C. Cir. 2010), aff’g in part, rev’g and remanding in part 

(2008); Tigers Eye Trading, LLC v. Commissioner, 

, 117 (2012),
aff’d in part, rev’d in relevant part sub nom. Logan Tr. v. Commissioner, 616 F.
App’x 426 (D.C. Cir. 2015). These cases, with the exception of Thompson, each
involved a court’s jurisdiction in a partnership-level proceeding. Here we
determine our jurisdiction in a partner-level case.
                                       - 40 -

[*40] imposing the penalty would also require determining affected or non-

partnership items such as outside basis.” 

However, a court would not

have jurisdiction to “make a formal adjustment” to the partner’s outside basis. 

see also Logan Tr. v. Commissioner, 616 F. App’x. 426, 429 (D.C. Cir.

2015), aff’g in part, rev’g in relevant part Tigers Eye Trading, LLC v.

Commissioner, 

(2012); Petaluma FX Partners, LLC v. 

.

      Respondent attempts to distinguish an impermissible adjustment of outside

basis from a determination that outside basis in a sham partnership is zero. The

determination of whether a TEFRA partnership is a sham or bona fide is a

partnership item properly made at the partnership level. Petaluma FX Partners,

LLC v. 

. Respondent argues that once a

partnership-level case determines the partnership was a sham, the adjustment of

outside basis to zero does not require a partner-level determination. In dicta,

responding to a point raised in an amicus brief, the Supreme Court in Woods

observed that where a partnership is a sham and disregarded for tax purposes, the

determination of the partner’s outside basis may not require a partner-level

determination to adjust outside basis and thus the adjustment may be

computational. 

n.2. The Court stated that the amici’s
                                         - 41 -

[*41] argument “assumes that the underpayment would not be exempt from

deficiency proceedings because it would rest on outside basis.” 

further observed: “Even an underpayment attributable to an affected item is

exempt so long as the affected item does not ‘require partner-level

determinations,’ * * * and it is not readily apparent why additional partner level

determinations would be required before adjusting outside basis in a sham

partnership.” 

      Woods did not, however, answer the question of whether the partner-level

adjustment of outside basis incident to a deficiency determination is computational

and the Commissioner may directly assess the resulting tax against the purported

partners or whether the adjustment requires a partner-level determination and the

issuance of a notice of deficiency. We have stated that Woods provided “no direct

answer” to this question. Thompson v. Commissioner, T.C. Memo. 2014-154, at

*7 n.4, aff’d, 

(8th Cir. 2016). We have also suggested in dicta that

in cases involving sham, disregarded partnerships, an adjustment to zero of a

purported partner’s outside basis does not require “further partner-level

determinations” because outside basis is automatically zero. Greenwald v.

Commissioner, 

, 316 (2014). Greenwald involved a bona fide

partnership where a partner-level determination would be required to determine
                                        - 42 -

[*42] outside basis. However, in Greenwald we relied on Tigers Eye Trading,

LLC v. Commissioner, 

, which was subsequently reversed. Logan Tr.

v. Commissioner, 616 F. App’x 426.

      At the outset we note that partner-level determinations are clearly necessary

relating to the tax treatment of the assets distributed in a liquidation from a sham

partnership irrespective of the fact that the partnership is a sham. Napoliello v.

Commissioner, 

(9th Cir. 2011), aff’g T.C. Memo. 2009-104;

Domulewicz v. Commissioner, 

, 20 (2007), aff’d in part, rev’d in part

sub nom. Desmet v. Commissioner, 

(6th Cir. 2009). Partner-level

determinations are required regarding the reporting of the subsequent disposition

of the distributed assets by the purported partners, including the partners’ holding

periods of the assets, the character of the gain or loss on the disposition of the

assets, and whether the disposed assets were in fact the assets distributed by the

sham partnership. Domulewicz v. Commissioner, 

. In this case

there was no liquidating distribution of assets from a sham partnership.

      When a court in a partnership-level case holds that a partnership is a sham,

the logical conclusion is that the purported partners would not have outside bases

in the sham partnership greater than zero that would allow the purported partners

to claim loss deductions on the sale of their partnership interests. A taxpayer
                                        - 43 -

[*43] cannot have a basis in an asset that does not exist for Federal tax purposes.

; Logan Tr. v. Commissioner, 616 F. App’x at 429 (where a

partnership is a sham and “never existed, * * * no partner could have any outside

basis in the entity”); Greenwald v. Commissioner, 

. This

conclusion, however, does not confer jurisdiction on the Court in a partnership-

level case to determine outside basis. 

. We note that the

District Court in Kearney did not make any findings with respect to Lincoln’s

outside basis in Kearney Partners; it was without jurisdiction to make any such

findings.

      Under section 6226(f) a court reviewing a petition for readjustment of

partnership items generally has jurisdiction to determine “partnership items * * *

[and] the proper allocation of such items among the partners”. However, in the

limited instance of an accuracy-related penalty relating to outside basis, section

6226(f) specifically grants the Court jurisdiction to provisionally impose the

penalty that “relates to an adjustment to a partnership item” even though the

penalty may depend on partner-level determinations. Thus, the Court can

provisionally determine the penalty on the basis of another determination that it

does not have jurisdiction to make.
                                        - 44 -

[*44] The Supreme Court recognized that “every penalty must be imposed in

partner-level proceedings after partner-level determinations”. 

. Likewise, the determination of a partner’s outside basis can be made only at

the partner level after partner-level determinations. Thompson v. Commissioner,

, 872 (8th Cir. 2013); Petaluma FX Partners, LLC v. 

(acknowledging a sham partnership results in an outside basis

of zero but holding that the court in a partnership-level case does not have

jurisdiction to determine outside basis). A partner-level determination is required

even where the partnership is a sham.

      While the Supreme Court’s dicta in Woods gives us pause, we conclude that

the adjustment of outside basis in a sham partnership requires a partner-level

determination. No Court of Appeals has discussed the question of whether the

adjustment of outside basis could be computational. At this late date in the life of

the TEFRA partnership provisions, it would be unwise for us to introduce

uncertainty in the application of this well-worn law.11 It is logical, as the Supreme

Court suggests, to conclude Lincoln’s outside basis in its Kearney partnership

interest was zero. If so, Lincoln could not have incurred a loss on the sale of its


      11
       Congress repealed the TEFRA procedures in the Bipartisan Budget Act of
2015, Pub. L. No. 114-74, sec. 1101(a), 129 Stat. at 625.
                                        - 45 -

[*45] Kearney partnership interest to pass through to Mr. Sarma. “Neither the

Code nor the regulations * * * require that partner-level determinations actually

result in a substantive change to a determination made at the partnership level.”

Domulewicz v. Commissioner, 

. The adjustment to outside basis is

made at the partner level and requires a partner-level determination. Accordingly,

the 2016 notice is valid, and we will deny respondent’s motion to dismiss.

      Petitioners advance a number of objections relating to the Kearney decision

and argue that its findings are irrelevant and erroneous, resulting in a need for

partner-level determinations. It appears that petitioners seek to relitigate the issues

decided in Kearney; they have yet to identify any component of outside basis left

unresolved after Kearney Partners was held to be a sham or to articulate a position

for the Court to find that Lincoln’s outside basis in Kearney was greater than zero.

They argue that the District Court did not have jurisdiction over Mr. Sarma

because he was not a party in that case, Mr. Sarma opted out of Kearney, and

finally Kearney supports the deduction of the Sarma loss because the District

Court reallocated the gain and loss from the FX straddles to Mr. Sarma in his

individual capacity after holding the three partnerships were shams. They also

argue that Sarma I supports their position that Mr. Sarma was not a partner during

the TEFRA tax periods and is not bound by Kearney.
                                        - 46 -

[*46] As explained the Kearney decision may result in adjustments to affected

items for tax periods over which the District Court lacked jurisdiction. The

decision may change a partner’s tax liability in a tax period different from the

period at issue in the TEFRA proceedings. See Kligfeld Holdings v.

Commissioner, 

. In Sarma I the parties merely stipulated that

petitioners did not concede they had an interest in Kearney or concede that it could

affect their tax liabilities for 2001 through 2004. Mr. Sarma did not have the right

to opt out of TEFRA because he was not a notice partner with the right to receive

the NBAP. See sec. 6223(e) (providing notice partners with statutory rights where

an NBAP is not timely issued). The District Court held that Mr. Sarma did not

elect to opt out of TEFRA. Kearney, 

at *5-*7. Although

respondent mistakenly included a letter in the FPAA stating that Mr. Sarma had a

right to opt out of TEFRA because of an untimely NBAP, he later informed Mr.

Sarma of this mistake. As no FPAA is required for Lincoln’s December 31, 2001,

tax period, no right to opt out of TEFRA can arise.

      Petitioners argue in the alternative that Kearney supports their entitlement to

loss deductions because the District Court sustained the FPAA adjustments and

reallocated the income and loss from the FX straddles to Mr. Sarma in his

individual capacity. Accordingly, they argue that Mr. Sarma had bases in the FX
                                        - 47 -

[*47] straddles to claim loss deductions on the transactions. We reject petitioners’

characterization of Kearney; it did not reallocate the FX straddle income and

losses to Mr. Sarma. The District Court sustained the adjustments in the FPAAs,

which included reallocation of the gain and loss from the FX straddles to Mr.

Sarma. Petitioners argue that in the FPAAs respondent recognized the FX

straddles for tax purposes. However, the District Court found that the FX

straddles were shams and disregarded for Federal tax purposes. In its judgment

the District Court held the portion of the FPAAs that reallocated the income and

loss to Mr. Sarma to be moot. Accordingly, the District Court did not reallocate

the income and loss from the FX straddles to Mr. Sarma.

V.    Multiple Notices of Deficiency

      Generally the Commissioner is precluded from issuing more than one notice

of deficiency for a taxable year. Sec. 6212(c). An exception to the one deficiency

notice rule exists for affected items that require partner-level determinations. Sec.

6230(a)(2)(C). Petitioners argue that the Sarma loss is not an affected item and

not a computational adjustment. They argue that respondent was precluded from

issuing the 2016 notice because it is an invalid further notice of deficiency for

2001 through 2004. For the reasons stated above, the Sarma loss deduction is an
                                        - 48 -

[*48] affected item that requires a partner-level determination. The exception

applies. Accordingly, respondent is not precluded from issuing the 2016 notice.

         In reaching our holding, we have considered all arguments made, and, to the

extent not mentioned above, we conclude that they are moot, irrelevant, or without

merit.

         To reflect the foregoing,


                                                 An appropriate order will be issued.