CONTENTS Page Background .............................................................. 77 Discussion .............................................................. 88 I. Introduction: Complexity of Income Tax Treatment of Partners and Partnerships ................................................. 88 A. Overview of Subchapter K ......................................... 88 B. TEFRA ............................................................ 88 1. In General ..................................................... 88 2. TEFRA Penalty Litigation Structure Before TRA 1997 ............. 89 3. TEFRA Penalty Litigation Structure After TRA 1997 .............. 90 C. Attempted Exploitation by Tax Shelter Promoters of Complex Interactions and Disconnects of Subchapter K Substantive Rules and TEFRA Procedural Rules ............................... 92 II. Jurisdiction Under TEFRA When Entity Filing Partnership Return Is Not a Partnership or Does Not Exist .................... 95 A. TEFRA Procedures Apply When Entity That Filed Partnership Return Is Not a Partnership or Does Not Exist: Sections 6226(f) and 6233 ...................................... 95 B. Jurisdiction To Determine Items of Disregarded Entity: Section 301.6233-1T(a) and (c), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6779, 6795 (Mar. 5, 1987) ........... 97 C. Jurisdiction To Determine Applicability of Any Penalty That Relates to Adjustment of Entity Item: Section 6226(f) .......... 100 III. Jurisdiction To Enter Stipulated Decision as Written With Respect to Partnership Items .................................... 100 A. Provisions of the Stipulated Decision ............................ 100 B. Disregard of Tigers Eye .......................................... 102 C. Items of Tigers Eye .............................................. 102 D. First Decision Paragraph ......................................... 103 1. Partnership Loss and Deductions ................................ 104 2. Contributions and Distributions ................................ 104 a. Items Related to Contributions ............................... 104 b. Items Related to Distributions ............................... 106 3. Adjustment of Items to Zero .................................... 107 E. Second Decision Paragraph ........................................ 107 1. Basis in Property Distributed by Disregarded Entity ............ 108 2. Outside Basis .................................................. 109 a. Petaluma Superseded by Mayo Found. and Intermountain: TEFRA Regulations Must Be Applied .......................... 110 b. Determination of Outside Basis: General Rule Under Section 705(a) ............................................. 112 c. Determination of Outside Basis: Alternative Rule Under Section 705(b) ............................................. 114 d. Outside Basis Is a Partnership Item .......................... 115 i. Required To Be Taken Into Account Under Subtitle A ......... 115
ii. More Appropriately Determined at the Partnership Level: Outside Basis Determined Under the General Rule ..................................................... 116 iii. More Appropriately Determined at the Partnership Level: Outside Basis Determined Under Alternative Rule ..................................................... 118 iv. More Appropriately Determined at the Partnership Level: Outside Basis When the Partnership Is Disregarded .............................................. 118 e. Misapplication of Dial USA, Inc. v. Commissioner ............. 119 f. Validity of the Regulation Under the Chevron Two-Step Standard ................................................... 124 g. Outside Bases of Tigers Eye's Purported Partners Are Partnership Items .......................................... 126 IV. Jurisdiction To Enter Stipulated Decision as Written With Respect to Application of Penalties .............................. 128 A. Items Adjusted in the Stipulated Decision and the Application of Accuracy-Related Penalties Thereto Within the Jurisdictional Limitations of Petaluma II ...................... 130 1. 40% Gross Basis Misstatement Penalty ........................... 131 2. 20% Negligence Penalty ......................................... 133 3. Conclusion ..................................................... 134 B. Petaluma II Notwithstanding, Jurisdiction To Determine the 40% Penalty Applies to the Overstatement of the Basis of the Distributed Property ....................................... 134 1. Applicability of the 40% Penalty to the Overstatement of the Basis of the Distributed Property ........................ 134 2. Petaluma III: The Court Was Bound by the Law of the Case and the Rule of Mandate To Follow Petaluma II Dicta on Lack of Jurisdiction Over Outside Basis ............. 136 3. TRA 1997: The Tax Court Has Jurisdiction To Determine Applicability of Penalties That Relate to Adjustment of Partnership Items ......................................... 139 V. Conclusion .......................................................... 143
BEGHE, Judge:
Following entry of a stipulated decision on December 1, 2009, this Son of BOSS
Participating partner argues that the stipulated decision upholds adjustments in the final partnership administrative adjustment (FPAA) and applies accuracy-related penalties that exceed this Court's jurisdiction under section 6226(f),
We observe that the limiting holdings in Petaluma II were the result of a concession by the Government that the Court of Appeals accepted without any discussion of the applicable regulations. In an opinion issued after Petaluma II was filed, Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. ___, 131 S.Ct. 704 (2011), the Supreme Court emphatically reminded lower courts that they must defer to regulations that satisfy the two-step Chevron
Under the assumption that this Court was bound by the holdings of the Court of Appeals in Petaluma II, in respondent's response to participating partner's motion to vacate and revise the decision, respondent made the same concession as the Government made in Petaluma II.
Subject-matter jurisdiction relates to a court's statutory or constitutional power to hear a given type of case. United States v. Cotton, 535 U.S. 625, 630 (2002); United States v. Morton, 467 U.S. 822, 828 (1984); Alikhani v. United States, 200 F.3d 732, 734 (11th Cir. 2000). The Supreme Court has held that "subject-matter jurisdiction, because it involves a court's power to hear a case, can never be forfeited or waived." Cotton, 535 U.S. at 630. "[S]ubject matter jurisdiction is an unwaivable sine qua non for the exercise of federal
Whether a court has subject matter jurisdiction to adjudicate the merits of a controversy is a question of law. Taylor v. Voss, 271 U.S. 176, 186 (1926) ("a petition for revision will lie to bring up for review the question of law whether the court of bankruptcy has jurisdiction to adjudicate the merits of such controversy in a summary proceeding"); Adkison v. Commissioner, 592 F.3d 1050, 1052 (9th Cir. 2010) ("Whether the Tax Court has subject matter jurisdiction is a question of law and thus reviewed de novo"), aff'g 129 T.C. 97 (2007); United States v. Moore, 443 F.3d 790, 793 (11th Cir. 2006). The meaning of a statutory term is also a question of law. Crane v. Commissioner, 331 U.S. 1, 15 (1947) (Tax Court's determinations of statutory terms "announced rules of general applicability on clear-cut questions of law").
Neither the Supreme Court nor an appellate court is bound to accept the Government's concession that the court below erred on a question of law. Orloff v. Willoughby, 345 U.S. 83, 88 (1953). Similarly, the Tax Court need not accept a party's concession on a question of law, particularly when to do so would strip the Court of its jurisdiction. See Charlotte's Office Boutique, Inc. v. Commissioner, 121 T.C. 89, 102 (2003), aff'd, 425 F.3d 1203 (9th Cir. 2005).
The Golsen rule does not apply where the precedent from the Court of Appeals constitutes dicta or contains distinguishable facts or law. See, e.g., Hefti v. Commissioner, 97 T.C. 180, 187 (1991) (dictum not controlling), aff'd, 983 F.2d 868 (8th Cir. 1993); Metzger Trust v. Commissioner, 76 T.C. 42, 72-74 (1981) (factual distinctions render Golsen rule not squarely on point), aff'd, 693 F.2d 459 (5th Cir. 1982); Kueneman v. Commissioner, 68 T.C. 609, 612 n.4 (1977) (distinct legal question not governed by the Golsen rule), aff'd, 628 F.2d 1196 (9th Cir. 1980). As we stated in Lardas v. Commissioner, 99 T.C. 490, 493-495 (1992), the Golsen rule applies only where the "clearly established" position of a Court of Appeals signals "inevitable" reversal upon appeal.
The Court of Appeals for the D.C. Circuit recognizes its "obligation to explore any promising avenue to * * * [the inferior court's] jurisdiction, whether or not suggested by the parties". Ass'n of Am. Med. Colleges v. Califano, 569 F.2d 101, 111 (D.C. Cir. 1977); see also Da Silva v. Kinsho Int'l Corp., 229 F.3d 358, 361 (2d Cir. 2000) ("the issue of subject matter jurisdiction is one we are required to consider, even if the parties have ignored it or, as here, have switched sides on the issue"). Because the Court of Appeals did not consider the precise issue we decide herein, Golsen does not apply. See Read v. Commissioner, 114 T.C. 14 (2000), aff'd without published opinion sub nom. Mulberry Motor Parts, Inc. v. Commissioner, 273 F.3d 1120 (11th Cir. 2001); Estate of Branson v. Commissioner, 113 T.C. 6, 34 (1999), aff'd, 264 F.3d 904 (9th Cir. 2001).
Accordingly, we reject respondent's concession and apply the applicable regulations, authorized by sections 6231(a)(3) and 6233, and hold that this Court has jurisdiction to enter the stipulated decision as written, even to the extent it adjusts outside basis to zero and applies the 40% gross basis misstatement penalty under section 6662(h) to the deficiency
Entry of the stipulated decision in this 1999 taxable year Son of BOSS case was preceded by our opinion in Tigers Eye Trading, LLC v. Commissioner, T.C. Memo. 2009-121 (Tigers Eye I).
The subject transaction was one of a number of such transactions promoted by Sentinel Advisors, LLC (Sentinel),
Tigers Eye was a Delaware limited liability company formed in late September 1999, ostensibly to engage in foreign currency trading but in reality to generate paper losses to offset taxpayers' otherwise taxable capital gains. On October 1, 1999, the Logan Trusts each acquired a pair of offsetting long and short foreign currency options through AIG, which they then contributed along with cash to become partners in Tigers Eye on October 9, 1999. The Logan Trusts inflated their adjusted bases in Tigers Eye to reflect their contributions of the long options without reducing those bases to reflect Tigers Eye's assumption of their obligations under the short options. The basis inflation is premised on (1) treating each purchased option separately from each sold option, (2) each purchased option's having a basis equal to the gross premium in the hands of both the Logan Trusts and Tigers Eye, (3) treating the assignment to and assumption by Tigers Eye of the contingent obligation to satisfy the sold option separately from the purchased option for purposes of section 752, and (4) disregarding the contingent obligation to satisfy the sold option in determining outside basis in the partnership under the authority of Helmer v. Commissioner, T.C. Memo. 1975-160.
An unrelated entity, the Batts Group, also acquired interests in offsetting foreign currency options through AIG that were transferred to Tigers Eye and also received other property in liquidation of its interest in Tigers Eye.
During December 1999 Sentinel caused Tigers Eye to unwind or terminate the paired options at a net loss.
On April 14, 2000, Tigers Eye filed a Form 1065, U.S. Partnership Return of Income, for its 1999 taxable year. On March 7, 2005, respondent issued an FPAA to the Tigers Eye partners.
The FPAA comprises (1) Letter 1830, Notice of Final Partnership Administrative Adjustment, (2) Form 870-PT, Agreement for Partnership Items and Partnership Level Determinations as to Penalties, Additions to Tax, and Additional
The Schedule of Adjustments adjusted to zero the following five items:
A. Capital Contributions (Sched. M-2,
line 2) $698,595
B. Distributions of Property other than
Money (Sched. M-2, line 6b) 365,446
C. Outside Partnership Basis 24,500,059
D. Other Deductions (Sched. K, line 11) 11,314
E. Ordinary Income, Other Income
(Loss) (Sched. K, line 7) (242,186)
Items A, B, D, and E are each identified as the adjustment of a line item on the Tigers Eye 1999 Form 1065. Item C (Outside Partnership Basis) is not such an item and does not correspond to any line item on the partnership return. Unlike the item A, B, D, and E amounts, each of which is identified as the adjustment of a line item on the Tigers Eye 1999 Form 1065, the item C amount does not appear on the partnership return or on the Schedules K-1, Partner's Share of Income, Credits, Deductions, etc., of the partnership return and sent to the partners.
Only two of the foregoing adjustments were to items appearing on the partnership return that directly flowed through to the returns of the Logan Trusts and thence to Mr. Logan's individual return. These two adjustments change to zero two items that appeared on Schedule K of the partnership return: "Other Deductions" of $11,314 (appearing on line 11, Schedule K, page 3, of the partnership return) and the negative amount "($242,186)" reported for "Ordinary Income, Other Income (Loss)" (on line 7, Schedule K, Partners' Shares of Income, Credits, Deductions, etc., page 3, of the partnership return). These line items were described in greater detail in Statements 1 and 2 of the return, reproduced below.
The partnership return Schedules K-1 for the Logan Trusts show that their respective shares of the entries on lines 7 and 11 of Schedule K were a loss of $52,583 and other deductions of $2,136, respectively, for a total loss of $157,749 and total other deductions of $6,408 that flowed from the partnership return through the returns of the Logan Trusts to Mr. Logan's 1999 Federal income tax return.
Statement 6 on the partnership return, "PARTNERS' CAPITAL ACCOUNT SUMMARY", shows "Capital Contributed" and "Withdrawals" (the latter is identical to "Distributions of Property Other Than Money") totaling $698,595 and $365,446, respectively, that were also adjusted to zero by the FPAA.
The "Capital Contributions" of $698,595 shown by the partnership return and zeroed out by the FPAA (and the stipulated decision) was the sum of the cash contributed by all the partners plus the net value of the paired options that the Logan Trusts and the Batts Group had ostensibly contributed to the partnership; this net value was arrived at by netting the premiums on the long and short options. This partnership return reporting differed from the inflated bases claimed by the Logan Trusts through the tax shelter
The "Withdrawals" ("Distributions of Property Other Than Money") of $365,446 zeroed out by the FPAA was the book value (the aggregate purchase price/cost) of the foreign currency and corporate shares purchased by Sentinel through Tigers Eye on behalf of the Logan Trusts and the Batts Group for distribution to them.
The "EXHIBIT A — Explanation of Items" made the following additional adjustments or determinations: (1) Tigers Eye's existence as a partnership had not been established as a fact; (2) Tigers Eye had no business purpose other than tax avoidance, lacked economic substance, and was an economic sham so that Tigers Eye and the transactions in which it claimed to have participated should be disregarded in full; and (3) Tigers Eye had been formed or availed of, within the meaning of section 1.701-2, Income Tax Regs., for a principal purpose of improperly reducing the partners' Federal income tax liabilities.
The Explanation of Items went on to make alternative adjustments or determinations premised on regarding Tigers Eye as a partnership that had received the paired foreign currency options as contributions and assignments from the option partners (the Logan Trusts and the Batts Group) and thereafter distributed foreign currency and listed shares of stock to them in liquidation of their partnership interests. In that regard, the Explanation of Items determined that (1) the partners "have not established [under section 723] adjusted bases in their respective partnership interests in amounts greater than zero"; (2) "the purported partners of Tigers Eye did not enter into the option positions and Tigers Eye did not purchase the foreign currency or [listed] stock with a profit motive for purposes of section 165(c)(2)"; and (3) the obligations under the sold options should be netted against the purchased options so that "any * * * claimed increases in the outside bases in Tigers Eye resulting from the contributions of the sold [sic "purchased"] options should be disallowed". The alternative adjustments described in this paragraph have been rendered inapplicable by the stipulated decision's adoption of the primary adjustments disregarding
Finally, the Explanation of Items determined at the partnership level that accuracy-related penalties to be imposed at the individual taxpayer level apply "to all underpayments of tax attributable to adjustments of partnership items of Tigers Eye Trading, LLC". The Explanation of Items went on to state:
Sentinel, the tax matters partner, filed the petition in this case but claims to have no direct financial interest in its outcome. Mr. Logan, as trustee of Logan Trust I,
Partnership Item As Reported As Determined
Ordinary Income, Other
Income (Loss) ($242,186) $-0-
Deductions, Other Deductions $11,314 $-0-
Distributions of Property other than Money $365,446 $-0- Capital Contributions $698,595 $-0-
On November 25, 2009, the Court issued an order striking the case from the November 30, 2009, Washington, D.C., special trial session. On December 1, 2009, the Court entered the stipulated decision.
The Court's gratification from receipt and entry of the stipulated decision was short lived. On January 12, 2010, the Court of Appeals for the D.C. Circuit issued Petaluma II. One week later, on January 19, 2010, participating partner filed the motion for leave to file a motion to revise the stipulated decision and lodged the motion to revise decision. On November 30, 2010, the Court granted leave and the motion to revise decision was filed.
A partnership is not taxed as an entity, and its items of income and loss flow through to its partners. Sec. 701. Partnerships are required to file annual information returns reporting the partners' distributive shares of income, deductions, and other partnership items. Sec. 6031. The individual partners report their distributive shares of the partnership items on their Federal income tax returns. Secs. 701-704.
The substantive law governing the income taxation of partners is in subchapter K of chapter 1 of the Code (subchapter K). Subchapter K creates a detailed and complex system of rules for characterizing transactions between the partnership and the partners, computing and/or characterizing partnership income, assets, and liabilities, allocating those items among the partners, and determining and making adjustments to a partner's basis (cost for tax purposes under section 1012 except as otherwise provided in subchapter K) in the partnership for his share of those items. The purpose of subchapter K is "to permit taxpayers to conduct joint business (including investment) activities through a flexible economic arrangement without incurring an entity-level tax." Sec. 1.701-2(a), Income Tax Regs.
The unified audit and litigation procedural rules applicable to partnerships and their partners were enacted by Congress in the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No. 97-248, sec. 402, 96 Stat. at 648, and amended by Congress in the Taxpayer Relief Act of 1997 (TRA 1997), Pub. L. No. 105-34, sec. 1238, 111 Stat. at 1026.
Before Congress enacted TRA 1997, any penalty, addition to tax, or additional amount (collectively, penalty) related to adjustment of a partnership item or items in a TEFRA proceeding at the partnership level was generally treated as an affected item that required a factual determination in a subsequent proceeding at the partner level. See N.C.F. Energy Partners v. Commissioner, 89 T.C. 741, 744 (1987); sec. 301.6231(a)(5)-1T(d), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6790 (Mar. 5, 1987). Before Congress enacted TRA 1997, the Tax Court lacked jurisdiction in a partnership-level proceeding to decide the applicability of partnership-item penalties. See N.C.F. Energy Partners v. Commissioner, 89 T.C. at 744. Rather, partnership-item penalties were determined at the partner level as affected items in a deficiency proceeding after the related partnership-level proceeding had been completed. Procedurally, this made sense, inasmuch as the ultimate liability of each individual partner depended, almost invariably, upon his ability to sustain his individual reasonable cause/good faith defenses under section 6664(c), irrespective of whether the application of the penalty originated
TRA 1997 sec. 1238 made a comprehensive set of procedural amendments to the regime for the determination of penalties under TEFRA:
(1) By amending section 6221, TEFRA's introductory jurisdictional provision, to require the applicability of any partnership-item penalty to be determined at the partnership level ("Except as otherwise provided in this subchapter, the tax treatment of any partnership item (and the applicability of any penalty * * * which relates to an adjustment to a partnership item) shall be determined at the partnership level" (emphasis added));
(2) by amending and expanding section 6226(f), on the scope of judicial review by the Tax Court, the Court of Federal Claims, or Federal District Courts with which a petition to review an FPAA is filed, i.e., in a partnership-level proceeding, to provide that such court "shall have jurisdiction to determine" not only all partnership items and their allocations among partners but also "the applicability of any penalty * * * which relates to an adjustment to a partnership item" (emphasis added);
(3) by amending section 6230(a)(2)(A)(i) to deprive the Tax Court of jurisdiction to determine partnership-item penalties in a partner-level deficiency proceeding ("(A) Subchapter B [sections 6211-6216 titled "Deficiency Procedures in the Case of Income, Estate, Gift and Certain Excise Taxes"] shall apply to any deficiency attributable to — (i) affected items which require partner-level determinations (other than penalties * * * that relate to adjustments to partnership items)");
(4) by adding section 6230(c)(1)(C), which allows a partner to file a claim for refund on the ground that "the Secretary erroneously imposed any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item"; and
(5) by amending section 6230(c)(4) to make conclusive the partnership-level determination regarding the applicability of any partnership-item penalty, but allowing the partner to
In its report underlying the amendments, the House Committee on Ways and Means provided the following explanation:
The foregoing recitation of these TRA 1997 amendments to TEFRA and their legislative history displays the common theme that unites them. The recitation makes clear that the applicability of the accuracy-related penalty or penalties that relate to the adjustment of partnership items would henceforth be determined in the partnership-level proceeding to determine the validity of the adjustments to partnership items by the FPAA. No longer would application of accuracy-related penalties be determined at the partner level by the resolution of a partner-level affected-items deficiency proceeding. Nevertheless, for all the reasons discussed in the
The substantive and procedural rules applicable to the income taxation of partners and partnerships are "distressingly complex and confusing".
The above quotation was not only an accurate description of past and present ills as of the time it was published — 1983 — but also a forecast of future developments, as exemplified by the Son of BOSS transactions that are central to the formation of the limited liability companies of Tigers Eye in the case at hand and Petaluma in the Petaluma case; they are a variation of the "bond and options sales strategy", which the Commissioner regards as an abusive tax shelter, see Notice 2000-44, 2000-2 C.B. 255, 256; supra note 1, and this Court has repeatedly so held, see, e.g., Carpenter Family Invs., LLC v. Commissioner, 136 T.C. 373, 375 (2011); 3K Invs. Partners v. Commissioner, 133 T.C. 112, 113 n.2 (2009); see also Kligfeld Holdings v. Commissioner, 128 T.C. 192, 194 (2007).
Taxpayers attempted to exploit the complexity of partnership substantive tax law by using Son of BOSS transactions to inflate artificially the basis of property ostensibly distributed by a partnership to the purported partners in liquidation of their partnership interests. Those attempts exploited the complexity of the TEFRA partnership procedural rules to impede the Government's ability to identify quickly and challenge abusive Son of BOSS transactions and to avoid the
Application of the TEFRA provisions is the most "distressingly complex and confusing" in tax shelter cases such as the case at hand and Petaluma where the Commissioner takes and sustains the primary position in the FPAA (and the parties agree or the taxpayer concedes) that an entity purporting to be a partnership is to be disregarded on grounds of sham or lack of economic substance. In such cases the entity is not a partnership for Federal income tax purposes, the persons holding interests in the entity are not partners, their interests in the entity are not interests in a partnership, and the transactions between the entity and the interest holders are not transactions between a partnership and its partners. Consequently, the substantive provisions of subchapter K simply do not apply to the entity, the persons holding interests in the entity, or their transactions with the entity and among themselves. However, pursuant to section 6233(a) and (b), the TEFRA procedural provisions applicable to partnerships do apply "to the extent provided by regulations" to an entity that has filed a partnership return and to the persons holding an interest in the entity even if it is not a partnership for Federal income tax purposes or even "if it is determined that there is no such entity". Sec. 301.6233-1T(c), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6795 (Mar. 5, 1987).
Generally, in partnership-level proceedings we have jurisdiction under section 6226(f) to determine all partnership items of the partnership for the partnership taxable year to which the FPAA relates, and we are not limited to the partnership items adjusted in the FPAA. Sec. 301.6226(f)-1T, Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6788 (Mar. 5, 1987). We also have jurisdiction to determine the proper allocation of those 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. Sec. 6226(f).
The TEFRA procedures and our jurisdiction in TEFRA proceedings are not limited to partnership items of valid business entities recognized as partnerships for Federal tax purposes. Pursuant to section 6233 and the regulations promulgated thereunder, if an entity that has filed a partnership return is determined not to be a partnership or not to exist, the TEFRA partnership procedures (statutory and regulatory) will apply to the entity, its items, and persons holding an interest in the entity. Sec. 301.6233-1T(a), (c), Temporary Proced. & Admin. Regs., supra. In such a case, the Court has jurisdiction to make the determinations that the entity is not a partnership and/or that it does not exist as well as determinations with respect to all items of the entity that would be partnership items, as defined in section 6231(a)(3) and section 301.6231(a)(3)-1, Proced. & Admin. Regs., if the entity had been a partnership. Sec. 301.6233-1T(a), (c), Temporary Proced. & Admin. Regs., supra.
When Congress enacted the TEFRA procedures and the Secretary first promulgated the temporary regulations, there were frequent controversies over whether an unincorporated business entity with two or more owners (often a limited partnership) was properly classified as a corporation or a partnership for Federal tax purposes under section 301.7701-2, Proced. & Admin. Regs., in effect at that time. Section 301.6233-1T(a), Temporary Proced. & Admin. Regs., supra, focuses on the resolution of such controversies and, if the entity is properly taxable as a corporation, gives the Court jurisdiction in the TEFRA proceeding to determine the taxable income of the corporation, which will also "serve as a basis for a computational adjustment reflecting the disallowance of any loss of credit claimed by a purported partner with respect to that entity."
Section 6233 provides that if a partnership return is filed for a taxable year but it is determined that no partnership exists, the TEFRA procedures still apply to the entity, its items, and persons holding an interest in the entity, to the extent provided in the regulations. In such a case, the TEFRA temporary regulations applicable to Tigers Eye's 1999 taxable year provide that the Court may make determinations with respect to all items of the entity (entity items) that "would be partnership items, as defined in section 6231(a)(3) and the regulations thereunder [section 301.6231(a)(3)-1, Proced. & Admin. Regs.], if * * * [it] had been a partnership". Sec. 301.6233-1T(a), Temporary Proced. & Admin. Regs., supra. Further, the TEFRA temporary regulations provide:
See also sec. 301.6233-1(a), (d), Proced. & Admin. Regs., supra (applicable for taxable years beginning on or after October 4, 2001).
Section 301.6231(a)(3)-1(a)(1)(i), Proced. & Admin. Regs., provides that partnership items include the partnership aggregate and each partner's share of items of income, gain, loss, deduction, or credit of the partnership. Partnership items also include "the legal and factual determinations that underlie the determination of the amount, timing, and characterization of items of income, credit, gain, loss, deduction, etc." Sec. 301.6231(a)(3)-1(b), Proced. & Admin. Regs.
The existence of a valid partnership is a partnership item. First, it must be taken into account in computing a purported partner's income taxes. "`When filling out individual tax returns, the very process of calculating an outside basis, reporting a sales price, and claiming a capital loss following a partnership liquidation presupposes that the partnership was valid.'" Petaluma II, 591 F.3d at 653 (quoting RJT Invs. X v. Commissioner, 491 F.3d at 736). Second, the existence of a valid partnership "is a sine qua non for determining the amount and characterization of all other partnership items." Id. The legal and factual determinations underlying the Court's determination that the entity is not a partnership and/or does not exist will determine the character of the items of income, credit, gain, loss, and deduction of the entity. Thus the legal or factual determination that establishes the existence or nonexistence of a partnership is an item that the Secretary has identified as being more appropriately decided at the partnership level than at the partner level. Id.
"[D]etermining whether there is a valid partnership necessarily controls whether there can be partnership income, partnership gain, partnership losses, and so forth." Petaluma II, 591 F.3d at 653. If the Court has determined that an entity that filed a partnership return is not a partnership and/or does not exist, there is no partnership income, partnership gain, or partnership loss. The items of the entity are not properly characterized as those of a partnership. The regulations provide that the Court's determination that an entity that filed a partnership return is not a partnership and is taxable as a corporation "will serve as a basis for a computational adjustment reflecting the disallowance of any loss or credit claimed by a purported partner with respect to that entity". Sec. 301.6233-1T(a), Temporary Proced. & Admin. Regs., supra. Because that section of the temporary regulation also applies to entities that do not exist, the determination that the entity is deemed not to exist and is not a partnership for Federal tax purposes will also serve as a basis for a computational adjustment reflecting the disallowance of any loss or credit claimed by a purported partner with respect to that entity. Notably, the regulation does not limit the computational adjustment to the disallowance of the purported partner's share of "partnership loss or credit" that flowed through to his return from the partnership return; the regulation extends the permissible computational adjustment to the disallowance of "any loss or credit claimed
If the Court determines that an entity that filed a partnership return is not a partnership, the TEFRA provisions, including section 6226(f), apply. Sec. 301.6233-1T(a), Temporary Proced. & Admin. Regs., supra. Pursuant to section 6226(f) the Court has jurisdiction to determine the applicability of any penalty that relates to an adjustment to a partnership item.
The first decision paragraph in the stipulated decision gives specific effect to four of the five scheduled adjustments made by the FPAA: Loss, Other Deductions, Distributions of Property Other Than Money, and Capital Contributions, omitting any reference to "Outside Partnership Basis". The $242,186 loss and the $11,314 of other deductions flowed directly through to the purported partners' returns. The deficiencies resulting from those adjustments do not require any facts to be determined in a partner-level proceeding. Therefore respondent may assess those deficiencies and the penalties applicable thereto without sending a statutory notice of deficiency.
By the second decision paragraph stating that the FPAA is correct the parties adopt and incorporate all determinations made in the FPAA, including the initial FPAA determination that Tigers Eye is disregarded for Federal income tax purposes. Notwithstanding that the first and third decision paragraphs omit any reference to "Outside Partnership Basis", the parties agree that the second decision paragraph, in determining that the FPAA is correct, implicitly upholds the FPAA's adjustment of outside partnership basis to zero and the application of the 40% penalty to the portion of any underpayment attributable to the gross valuation misstatement as provided by section 6662 (a), (b)(3), (e), and (h). Consequently, the 40% penalty will apply to the portion of the underpayment attributable to the gross misstatement of basis in the distributed property (the basis participating partner claimed was its outside basis in its partnership interest in Tigers Eye).
By the second decision paragraph of the stipulated decision, the parties have agreed and the Court has decided that the FPAA that is the subject matter of this case is correct. The decision upholds the initial FPAA determination that the partnership is a sham, lacks economic substance, and is disregarded for Federal income tax purposes. Thus, the stipulated decision reflects the parties' agreement that for Federal income tax purposes Tigers Eye does not exist and is not a partnership. Pursuant to section 6233 and the regulations thereunder, we have jurisdiction to make those determinations as well as determinations with respect to all items of Tigers Eye that would be partnership items, as defined in section 6231(a)(3) and section 301.6231(a)(3)-1, Proced. & Admin. Regs., if it had been a partnership. Pursuant to section 301.6233-1T(a) and (c), Temporary Proced. & Admin. Regs., supra, the TEFRA procedures apply to Tigers Eye, its items, and all persons holding interests in Tigers Eye, and the Court has jurisdiction under section 6226(f) to determine the applicability of any penalty that relates to an adjustment to an item of Tigers Eye. That conclusion is consistent with the holding of the Court of Appeals in the Petaluma case. Petaluma II, 591 F.3d at 652-654; Petaluma I, 131 T.C. at 92-97.
The Court has jurisdiction to make determinations with respect to all of Tigers Eye's items, including the legal and factual determinations that underlie the determination of the amount, timing, and characterization of items of income, credit, gain, loss, and deduction related to the transactions conducted by Tigers Eye. See sec. 301.6233-1T(a), (c), Temporary Proced. & Admin. Regs., supra; sec. 301.6231(a)(3)-1(b), Proced. & Admin. Regs. The determination that Tigers Eye is a sham and lacks economic substance is a factual determination that underlies the characterization of items of income, gain, and loss related to its transactions. Because Tigers Eye is a sham and had no real business purpose, it merely acted as nominee and agent for the option partners and the items related to the transactions involving the option spreads and purchases and distribution of stock and foreign
We also have jurisdiction to determine that items that purport to be partnership items do not exist and to adjust all such items to zero so that a computational adjustment can be made to reflect the disallowance of any loss or credit claimed by a purported partner with respect to the nonexistent Tigers Eye partnership. The items reported on the partnership return that were adjusted to zero in the first decision paragraph are such items.
By the first decision paragraph, the loss, deductions, capital contributions, and distributions reported by Tigers Eye on the partnership return are items adjusted to zero. Tigers Eye's purported partners claimed their proportionate shares of the loss and deductions on their returns. The option partners also claimed huge losses on the sale of the distributed property, which they characterized as property distributed to them in liquidation of their interests in a partnership purportedly acquired by contributing property to the purported partnership. The parties' agreement to the Court's determination that Tigers Eye is not a partnership for Federal income tax purposes "will serve as a basis for a computational adjustment reflecting the disallowance of any loss claimed by a purported partner with respect to that entity" (emphasis added), i.e., Tigers Eye, including the loss claimed on the sale of property purported to have been distributed to a purported partner on liquidation of a nonexistent partnership interest in Tigers Eye. See sec. 301.6233-1T(a), Temporary Proced. & Admin. Regs., supra. Pursuant to section 6233 and its implementing regulation, we have jurisdiction to determine that all items of Tigers Eye purported to be partnership items are adjusted to zero. The loss, other deductions, capital contributions, and distributions are identified in section 301.6231(a)(3)-1(a)(1)(i), (4), Proced. & Admin. Regs., as partnership/entity items that the Secretary determined
The Secretary determined in section 301.6231(a)(3)-1(a)(1)(i), Proced. & Admin. Regs., that the partnership aggregate and each partner's share of items of income, gain, loss, deduction, or credit of the partnership are partnership items more appropriately determined at the entity level. The $242,186 partnership loss and the $11,314 partnership other deductions are partnership items. We have jurisdiction to determine that, because Tigers Eye is not a partnership, Tigers Eye did not have any partnership loss or partnership deductions. See sec. 301.6233-1T(a), Temporary Proced. & Admin. Regs., supra. Thus, we have jurisdiction to adjust to zero the $242,186 loss and the $11,314 deduction, as provided in the first decision paragraph of the stipulated decision.
In section 301.6231(a)(3)-1(a)(4), Proced. & Admin. Regs., the Secretary decided that items relating to contributions to the partnership and distributions from the partnership are partnership items
Thus, the Secretary decided that items related to contributions to the partnership and distributions from the partnership that the partnership is required to determine for its books and records or for providing information to its partners are partnership items.
In section 301.6231(a)(3)-1(c)(2), Proced. & Admin. Regs., the Secretary provided the following illustrations of additional determinations the partnership is required to make for purposes of its books and records or for purposes of furnishing information to a partner that relate to contributions:
Under the regulation, for purposes of keeping its books and records and providing information to the option partners as a purported partnership, Tigers Eye was required to determine (1) the amount of money and (2) the character and basis of the paired options received from the purported partners. Tigers Eye needed to determine its basis in the paired options in order to compute the losses realized on the unwinding of the option spreads, which were part of the loss claimed on the partnership return. In determining the basis of the paired options, Tigers Eye needed to determine each partner's basis in the contributed property, including the amount of the liabilities to which the property was subject. Partnership items include the partnership aggregate and each partner's share of partnership liabilities, including determinations as to the amounts of the liabilities, whether the liabilities are nonrecourse, and increases or decreases during the taxable year. Sec. 301.6231(a)(3)-1(a)(1)(v), Proced. & Admin. Regs.
Tigers Eye was also required to determine the contributions for purposes of determining the partners' percentage interests in the purported partnership, the partners' shares of the partnership loss and deductions, and the amounts to which the purported partners were entitled on the purported liquidation of their interests.
Tigers Eye was required to make the same determinations for purposes of its books and records and providing information to the option partners with respect to the money and property it received in conducting the transactions as
In section 301.6231(a)(3)-1(c)(3), Proced. & Admin. Regs., the Secretary provided the following illustrations of additional determinations the partnership is required to make for purposes of its books and records, or for purposes of furnishing information to a partner that relate to distributions:
Under the regulation, for purposes of keeping its books and records and providing information to the option partners as a purported partnership, Tigers Eye needed to determine the character of the amount distributed to an option partner; i.e., that it was a distribution in liquidation of the partner's interest in the purported partnership. Having made that determination, Tigers Eye needed to determine the amounts to be distributed to the purported partners on liquidation of their interests. Tigers Eye needed to select the property to be
Tigers Eye was required to make the same determinations for purposes of its books and records and providing information to the option partners with respect to the property it distributed to them in conducting the transactions as nominee or agent on their behalves. Tigers Eye was required to determine the character of property distributed to an option partner; i.e., that it was a distribution of the property Tigers Eye purchased as nominee or agent of the option partners. Having made that determination, Tigers Eye needed to identify the property to be distributed, determine its basis in the property, and account for it on its books. Tigers Eye needed to provide that information to the option partners so that they could properly determine their bases in the distributed property.
Because Tigers Eye is not a partnership for Federal income tax purposes, it had no partnership items, there was no partnership loss, and there were no partnership deductions, no contributions to the purported partnership, and no distributions from a partnership to its purported partners. Adjustment of those items to zero is appropriate. The loss, deductions, capital contributions, and distributions that are adjusted to zero pursuant to the first decision paragraph are partnership items that this Court has jurisdiction to decide under section 6233 and section 301.6233-1T(a), Temporary Proced. & Admin. Regs., supra.
By the second decision paragraph the parties adopt and incorporate all determinations made in the FPAA, including the disregard of Tigers Eye, the adjustment of outside basis to zero, and the application of the 40% penalty to the underpayment attributable to gross valuation/basis misstatement. Participating partner asserts that under Petaluma II the Court does not have jurisdiction to decide outside basis or the applicability of the 40% penalty to an underpayment of
Pursuant to section 6233 and its regulation, we have jurisdiction to determine the items of Tigers Eye acting as nominee for the option partners. Tigers Eye was required to make determinations for purposes of its books and records and for providing information to the option partners with respect to the transactions it conducted as nominee or agent on their behalves.
An option partner is required to take his basis in the distributed property into account in computing his gain or loss on the sale of the property and computing his income tax taking into account that gain or loss. The Secretary has determined in section 301.6231(a)(3)-1(a)(4), Proced. & Admin. Regs., that items relating to distributions that the partnership is required to make for purposes of its books and records or for providing information to a partner are "more appropriately determined at the partnership level" and are partnership items. The regulation specifically provides that, for purposes of its books and records and providing information to a partner, the partnership needs to determine "[t]he adjusted basis to the partnership of distributed property". Sec. 301.6231(a)(3)-1(c)(3)(iii), Proced. & Admin. Regs.
Tigers Eye needed to account for the money it received from the option partners, the expenses it incurred on behalf of the option partners, the amounts received and spent on the receipt and unwinding of the paired options, and the cost of the foreign currency and stock purchased on behalf of the option partners. Tigers Eye needed to provide that information to the option partners so that they could properly report
Although the FPAA Schedule of Adjustments adjusted partnership distributions to zero, it did not mention or make any specific adjustment to the bases of the foreign currency and stock received by the option partners. However, pursuant to section 6226(f), regardless of whether the Commissioner specifically made adjustments in the FPAA, the Court has jurisdiction to determine "all partnership items of the partnership for the partnership taxable year to which the notice of FPAA relates, the proper allocation of such items among the partners, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item". Tigers Eye's basis in the foreign currency and stock (which is participating partner's basis) is a partnership/entity item we have jurisdiction to decide in this case. See sec. 301.6231(a)(3)-1(c)(3)(iii), Proced. & Admin. Regs. Participating partner acknowledges that the distributions reported on the partnership return filed by Tigers Eye is Tigers Eye's cost basis in the distributed property. Thus, the distributions shown on the Schedule K-1 issued to each option partner is Tigers Eye's cost basis in the property distributed to such partner.
Participating partner and petitioner agree that the second decision paragraph, in determining that the FPAA is correct, upholds the FPAA's adjustment of outside partnership basis to zero. Participating partner asserts that the stipulated decision
The adjustments made in the Tigers Eye FPAA are similar to those made in the Petaluma FPAA.
In Petaluma II, the Court of Appeals affirmed the Petaluma I holding that the determination that the partnership is a sham and is disregarded for Federal tax purposes is a partnership item the Tax Court has jurisdiction to decide in the partnership-level proceeding. In so doing, the Court of Appeals held that the Tax Court's jurisdiction in the case was governed by section 6233. The Court of Appeals then meticulously applied section 6231(a)(3) and the regulations
Next, contrary to the Tax Court's holding in Petaluma I that under the regulations outside basis was a partnership item, the Government conceded that outside basis was not a partnership item. The Court of Appeals accepted the Government's concession without any discussion of section 6233 or 6231 or the regulations under section 6231 upon which the Tax Court had relied. The Government argued that the Tax Court had jurisdiction in the partnership proceeding to determine the partners' outside bases as affected items whose elements are determined mainly from partnership items. The Court of Appeals rejected that argument and held that the Tax Court did not have jurisdiction in the partnership proceeding to determine the partners' outside bases, an affected item, despite the disregard of the partnership. Consequently, the Court of Appeals agreed with Petaluma that "since the Tax Court lacked jurisdiction to determine outside basis, it also lacks jurisdiction to determine that penalties apply with respect to outside basis because those penalties do not relate to an adjustment to a partnership item". Petaluma II, 591 F.3d at 655.
After Petaluma II was issued, the Supreme Court in Mayo Found., 562 U.S. ___, 131 S.Ct. 704, made it clear that Federal courts must defer to regulations interpreting the Code that satisfy the two-step Chevron standard. See Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842-843 (1984). More recently, in Intermountain Ins. Serv. of Vail, LLC v. Commissioner, 650 F.3d at 691, the Court of Appeals for the D.C. Circuit held that the deference given to regulations under Mayo Found. requires the Court to apply the definitions of statutory terms provided in valid TEFRA regulations rather than follow earlier caselaw.
The jurisdictional holdings of Petaluma II on outside basis and accuracy-related penalties have their genesis in the Government's concession that outside basis was not a partnership item. The Court of Appeals summarily accepted that concession without any reference to section 301.6233-1T, Temporary Proced. & Admin. Regs., supra, or section 301.6231(a)(3)-1, Proced. & Admin. Regs. In contrast, the Court of Appeals discussed and applied sections 6233 and 6231(a)(3), section 301.6233-1T(a), Temporary Proced. &
Because the Court of Appeals did not consider the regulation in concluding in Petaluma II that outside basis is an affected item, we believe that its decision on the outside basis issue in Petaluma II has been superseded by the intervening opinions of the Supreme Court in Mayo Found. and the Court of Appeals in Intermountain. Intermountain requires us to apply the TEFRA regulations rather than follow any contrary holding in Petaluma II, unless we hold the regulation to be invalid under the two-step Chevron standard as mandated by the Supreme Court in Mayo Found.
If, under the applicable regulations, outside basis can be a partnership item, as we believe it to be generally, and more particularly when the entity is disregarded for Federal income tax purposes, acceptance of the Government's concession effectively invalidates the regulation. Consequently, we will follow the Supreme Court's command in Mayo Found. and apply the TEFRA regulations rather than hold them invalid or inapplicable. In determining the validity of a regulation, we are not bound to follow Petaluma II where the Court of Appeals did not specifically consider the applicability of the regulation in deciding the issue. See Intermountain Ins. Serv. of Vail, LLC v. Commissioner, 650 F.3d at 702. We begin by identifying the factors that determine outside basis in a valid partnership, so as to set the stage for the corresponding analysis that applies when the partnership is disregarded.
Section 705(a) states the general rule for determining the adjusted basis of a partner's interest in a partnership. In relevant part, section 705(a) provides that the adjusted basis of a partner's interest in a partnership is his original basis as determined under section 722 (relating to contributions to a partnership) or section 742 (relating to transfers of partnership interests) increased by (1) the amount of money and his basis in property subsequently contributed to the partnership and (2) his distributable share of the income of the partnership
The partnership's assumption of a partner's liability and a reduction of a partner's share of the liabilities of the partnership are treated as distributions of money. Sec. 752(b). The partner's assumption of a liability of the partnership and an increase in a partner's share of the liabilities of the partnership are treated as contributions of money. Id. If, as a result of a single transaction, a partner incurs both an increase and a decrease in his share of partnership liabilities, only the net increase is treated as a contribution or the net decrease is treated as a distribution. Sec. 1.752-1(f), Income Tax Regs. Thus, if property contributed to the partnership is subject to indebtedness or if liabilities of the partner are assumed by the partnership, the increase and decrease in the partner's basis from the deemed contributions and distributions of money are netted and the contributing partner's outside basis is reduced by the portion of the indebtedness allocated to the other partners. Sec. 1.722-1, Income Tax Regs.
The provisions governing the determination of outside basis are intended to equate the aggregate of the partnership's inside bases in its assets with the aggregate of its partners' outside bases in their partnership interests. Salina P'ship LP v. Commissioner, T.C. Memo. 2000-352 (citing 1 William S. McKee et al., Federal Taxation of Partnerships and Partners, par. 6.01, at 6-3 (3d ed. 1997)). The carryover-basis rule in section 722 generally results in a matching of inside and outside bases upon the formation of a partnership. See Coloman v. Commissioner, 540 F.2d 427, 429 (9th Cir. 1976), aff'g T.C. Memo. 1974-78. The adjustments to basis to account for income and expenses from partnership operations
See Laney v. Commissioner, 674 F.2d 342, 345-346 (5th Cir. 1982), aff'g in part, rev'g in part on another ground T.C. Memo. 1979-491. The preamble to section 1.752-1T, Temporary Income Tax Regs., 53 Fed. Reg. 53143 (Dec. 30, 1988), states in pertinent part:
The determination of the partners' shares of partnership liabilities under section 752 is also complex, requiring a determination of each partner's liability for recourse debt and the proper allocation of nonrecourse debt. See secs. 1.752-1 through 1.752-5, Income Tax Regs.
Section 705(b) authorizes the Secretary to prescribe regulations under which the adjusted basis of a partner's interest
Under section 6231(a)(3), a partnership item must be (1) required to be taken into account for the partnership's taxable year under any provision of subtitle A, governing income taxes, and (2) identified by regulation as "more appropriately determined at the partnership level".
"A partner is required to determine the adjusted basis of his interest in a partnership only when necessary for the determination of his tax liability or that of any other person." Sec. 1.705-1(a)(1), Income Tax Regs. The regulation provides that it is necessary to determine a partner's outside basis (1) at end of a taxable year to determine the extent to which the partner may deduct his share of partnership loss or deductions and (2) on the date of sale or liquidation of his interest in the partnership. Id.
As the Court of Appeals stated in deciding that the validity of a partnership is a partnership item in Petaluma II, 591 F.3d at 653:
Under statutory authority, the Secretary has decided that items related to contributions to the partnership and distributions from the partnership that the partnership is required to determine for its books and records or for providing information to its partners are partnership items. Sec. 301.6231(a)(3)-1(a)(4), Proced. & Admin. Regs. The Secretary has also decided that, to the extent that a determination of an item relating to contributions and distributions can be made from the determination of contributions, distributions, and similar determinations that the partnership is required to make, that item is a partnership item. Sec. 301.6231(a)(3)-1(c)(2) and (3), Proced. & Admin. Regs. Conversely, to the extent that the determination of such an item requires other information, that item is not a partnership item. Id.
The regulation recognizes that a partner's basis in his partnership interest is an item relating to distributions and, in many instances, that the determination of that outside basis under the general rule of section 705(a) may be made solely from the determination of contributions, distributions, and similar determinations that the partnership is required to make — the partner's share of items of partnership income, credit, loss, deduction, and liabilities. If the partner has contributed property to the partnership that is subject to indebtedness, the contributing partner's outside basis is reduced by the portion of the indebtedness allocated to the other partners. Sec. 1.722-1, Income Tax Regs. Determination of the amounts and nature of those liabilities, whether they are nonrecourse or contingent, and each partner's share of each liability is a partnership item. Sec. 301.6231(a)(3)-1(a)(v), Proced. & Admin. Regs. A partner's share of partnership liabilities is determined under the complex regulations promulgated under section 752. Section 1.752-4(d), Income Tax Regs., requires a partner's share of liabilities to be calculated
Under the regulation, a partner's outside basis is not a partnership item (i.e., it is an affected item) only when and to the extent the determination requires other information. Sec. 301.6231(a)(3)-1(c)(3), Proced. & Admin. Regs. "Such other information would include those factors used in determining the partner's basis for the partnership interest that are not themselves partnership items." Id. (emphasis added). Examples of such factors would include the amount the partner paid to acquire his partnership interest from a transferor partner and that the transfer was not covered by an election under section 754. Sec. 301.6231(a)(3)-1(c)(2) and (3), Proced. & Admin. Regs.
When a partner acquires an interest in the partnership by purchase, the partnership may make optional adjustments to the basis of partnership property if an election is made under section 754. Under section 301.6231(a)(3)-1(a), Proced. & Admin. Regs., the optional adjustment, including the determination of the partner's initial cost basis in the partnership, is a partnership item, and the determination of the partner's adjusted outside basis can be made from the determination of distributions, contributions, and similar determinations, including the partner's initial cost basis, that the partnership is required to make. In that case, the partner's adjusted outside basis is a partnership item under the regulation. If no election is made under section 754, the determination of the partner's initial basis is not one that the partnership is required to make. Pursuant to section 301.6231(a)(3)-1(a), Proced. & Admin. Regs., to the extent the determination of the partner's adjusted basis requires information regarding the amount paid for the interest, it is not a partnership item. To that extent, it is an affected item. See sec. 301.6231(a)(5)-1T(b),
When a partner's outside basis is determined under the alternative rule of section 705(b), his basis is equal to his share of the adjusted basis of partnership property that would be distributable to him upon termination of the partnership. If the partnership makes a distribution to a partner in liquidation of the partner's interest in the partnership, the partnership's basis in the distributed property is a partnership item. Sec. 301.6231(a)(3)-1(c)(3), Proced. & Admin. Regs. The determination of outside basis under the alternative rule of section 705(b) may be made solely from the determination of distributions that the partnership is required to make when property is distributed in liquidation of a partner's interest in the partnership. In determining the amount of the distribution, the partnership must determine the partner's interest in the partnership and identify the property to be distributed and its basis in the property for purposes of its books and records and for providing information to the partner. Thus, when outside basis is determined under the alternative rule, it is a partnership item.
Section 301.6231(a)(3)-1(c)(1), Proced. & Admin. Regs., explicitly states that the illustrations therein are not exhaustive; there may be additional determinations of items relating to contributions and distributions that the partnership is required to make for purposes of its books and records or providing information to its partners. The partnership's existence for Federal income tax purposes is a determination the partnership is required to make that also relates to the proper tax treatment of contributions and distributions. If, as here, the parties agree and the Court determines on grounds of sham or lack of economic substance that the entity is not a partnership, then the purported partners are not partners
Moreover, pursuant to section 301.6233-1T(a), Temporary Proced. & Admin. Regs., supra, the determination that the entity is not a partnership serves as a basis for a computational adjustment reflecting the disallowance of any loss or credit claimed by a purported partner with respect to that entity, including the losses reported by the option partners on their sales of property purported to have been distributed to them in liquidation of their purported partnership interests. We have jurisdiction under section 6233 and its regulations to make all adjustments of items necessary to make that computational adjustment, including taking account of the absence of outside basis by adjusting it to zero.
Citing Dial USA, Inc. v. Commissioner, 95 T.C. 1, 4-6 (1990), and section 301.6231(a)(5)-1T(b), Temporary Proced.
Moreover, Dial involved the Court's jurisdiction to determine subchapter S items at the corporate level under the unified subchapter S audit and litigation provisions of the Subchapter S Revision Act of 1982 (SSRA), Pub. L. No. 97-354, sec. 4(a), 96 Stat. at 1691. The SSRA provisions, enacted shortly after TEFRA and set forth at former sections 6241 through 6245, have since been repealed by the Small Business Job Protection Act of 1996, Pub. L. No. 104-188, sec. 1307(c)(1), 110 Stat. at 1781, applicable to tax years beginning after December 31, 1996. Under SSRA, the TEFRA provisions that relate to partnership items and the judicial determination of partnership items were made applicable to subchapter S items except to the extent modified or made inapplicable by regulations. Sec. 6244. Subchapter S items were defined in section 6245 as "any item of an S corporation to the extent regulations prescribed by the Secretary provide that, for purposes of this subtitle such item is more appropriately determined at the corporate level than the shareholder level." The Secretary identified subchapter S items in section 301.6245-1T, Temporary Proced. & Admin. Regs., 52 Fed. Reg. 3003 (Jan. 30, 1987). The subchapter S items in that regulation are very similar to the partnership items identified in section 301.6231(a)(3)-1T, Temporary Proced. & Admin. Regs., supra, and they include items relating to contributions and distributions to the extent they can be made from those determinations and similar determinations that the corporation is required to make. The respective regulations, however, are markedly different from each other with
By contrast, the flush language of section 301.6231(a)(3)-1(c)(3), Proced. & Admin. Regs., provides:
Thus, the SSRA regulations defining subchapter S items modified the TEFRA regulations that relate to partnership items, making the determination of outside basis a partnership item under certain circumstances inapplicable to subchapter S items. The shareholder's basis in the S corporation stock was solely an affected item. By contrast, a partner's basis in the partnership is an affected item only "to the extent it is not a partnership item." Sec. 301.6231(a)(5)-1T(b), Temporary Proced. & Admin. Regs., supra. Section 6244 made the TEFRA provisions that relate to partnership items and the judicial determination of partnership items applicable to subchapter S items. There is no statute or regulation that makes the S corporation provisions applicable to partnerships. Consequently, the holding in Dial that the shareholder's basis in the stock of the corporation is not a subchapter S item is inapplicable to the issue of the extent to which or circumstance in which a partner's outside basis is or may be a partnership item.
An S corporation, like a partnership, is a passthrough entity, and pursuant to section 1366(a)(1) a shareholder must take into account his or her pro rata share of the S corporation's items of income, loss, deduction, or credit. However, an S corporation is not considered an aggregate of its shareholders
The computation of a shareholder's pro rata share of the S corporation's items of income is much simpler than the determination of a partner's distributable share of partnership items. A shareholder's pro rata share of the S corporation items is determined by assigning an equal amount to each share of outstanding stock. By contrast, a partner's distributive share of partnership items of income, loss, etc., is determined by the partnership agreement, provided the allocation has substantial economic effect. Sec. 704(a). Otherwise the partner's distributive share is determined in accordance with the partner's interest in the partnership, taking into account all the facts and circumstances. Sec. 704(b). That determination would require an analysis or determination of, inter alia, the partnership agreement, capital accounts maintained under general accounting practices, capital accounts maintained for tax purposes in cases where there is a difference, historical allocation of income and deduction items, implications of negative capital account balances, partners' liability for partnership debt, whether partnership debt is recourse or nonrecourse, partners' shares of
Determination of the partners' outside bases in their interests in a partnership that is recognized for Federal income tax purposes requires complex determinations of not only the amounts of partnership items that are elements of outside basis but also the partners' shares of those amounts, which are also partnership items. Those complex determinations must be made in the partnership proceeding, and most often there are no other factors to be determined at the partner level. As the argument in Helmer v. Commissioner, T.C. Memo. 1975-160, raised in Son of BOSS cases such as this case demonstrates, the effect of partnership liabilities on the partners' outside bases exacerbates the complexity of computing outside basis. Determination of the partners' shares of partnership liabilities and any changes in those shares are usually unrelated to adjustments of any partnership items of income, loss, deduction, or credit. The determination of one partner's share of any partnership item affects every other partner's share of that item. The complexity of determining a partner's basis in his partnership interest justifies the Secretary's determination that outside basis is a partnership item to be determined at the partnership level to the extent it requires no additional information that must be determined at the partner level.
By comparison, the determination of a shareholder's basis in his stock in an S corporation is relatively simple once the S corporation items of income, loss, deduction, and/or credit are determined at the corporate level (either as reported on the S corporation return and accepted by the Commissioner or as a result of a corporate-level proceeding). A shareholder's share of those S corporation items can be determined at the shareholder level on the basis of the number of shares in the S corporation without affecting any other shareholder's pro rata share. His basis in any property contributed to the S corporation can also be determined by his records. The relative simplicity of computing a shareholder's basis in the stock of an S corporation justified the Secretary's determination that stock basis was an affected item to be determined at the shareholder level.
We must follow the regulation, unless we hold it to be invalid under the principles of Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837 (1984). Under Chevron, we ask first whether Congress has addressed the precise question at issue. Id. at 842. Where the statutory text is ambiguous, we ask whether the agency's chosen interpretation is a "reasonable interpretation" of the enacted text. Id. at 844. We may not disturb the regulation unless it is "`arbitrary or capricious in substance, or manifestly contrary to the statute.'" Mayo Found., 562 U.S. at ___, 131 S. Ct. at 711 (quoting Household Credit Servs., Inc. v. Pfennig, 541 U.S. 232, 242 (2004)).
First, we ask whether the statute is "silent or ambiguous" on the issue in question such that the agency has room to interpret. Chevron, 467 U.S. at 843. In doing so, we use "traditional tools of statutory construction, including the statutory language and legislative history." Anderson v. DOL, 422 F.3d 1155, 1180 (10th Cir. 2005) (citing Chevron, 467 U.S. at 843 n.9). Thus we ask whether Congress' intent is clear with respect to whether the term "partnership item" in section 6231(a)(3) includes the partners' outside bases in the partnership. Section 6231(a)(3) defines the term "partnership item" as any item with respect to a partnership that is required to be taken into account for the partnership's taxable year under the provisions governing income taxes to the extent regulations prescribed by the Secretary provide that, for purposes of subtitle A, such item is more appropriately determined at the partnership level than at the partner level. A partner's basis in his partnership interest is an item that is required to be taken into account when the partner is determining the extent to which he may deduct partnership losses and expenses each year or the amount of income he may realize when he receives a distribution from the partnership. Therefore Congress has not excluded the partners' outside bases from the definition of partnership item.
We proceed to the second step and ask whether the regulation is "based on a permissible construction of the statute." Chevron, 467 U.S. at 843. If the Secretary's construction is reasonable, Chevron requires the Court to accept that
Nothing in section 6231(a)(3) unambiguously forecloses the Secretary from interpreting "partnership items" as including items relating to contributions to the partnership and distributions from the partnership to the extent that the items can be ascertained from determinations that the partnership is required to make with respect to an amount, the character of an amount, or the percentage interest of a partner in the partnership, for purposes of the partnership books and records or for purposes of furnishing information to a partner. They are items the partners are required to take into account in determining their income taxes for the partnership's taxable year. It is not arbitrary for the Secretary to decide that items that can be determined solely by contributions, distributions, and other similar items that the partnership is required to keep records of for purposes of its books and records or for providing information to its partners are more appropriately determined at the partnership level. They are items that can be determined only from other items that must be determined at the partnership level, and the determination with respect to one partner necessarily affects the other partners, e.g., determination of the basis in property distributed to one partner reduces the partnership basis in its remaining assets for purposes of its books and records. Determining the nature and amounts of liabilities assumed by the partnership as the result of one partner's contribution of property to the partnership affects the other partners' shares of those liabilities and their deemed contributions of money related to the increase in the partnership liabilities allocated to them.
The regulatory scheme under section 6231(a)(3) is technical and complex. We find that the Secretary considered the treatment of partnership items in a detailed and reasoned fashion before making a final decision. The regulations were promulgated pursuant to notice and comment procedures, "`a "significant" sign that a rule merits Chevron deference.'" Mayo Found., 562 U.S. at ___, 131 S. Ct. at 714 (quoting United States v. Mead Corp., 533 U.S. 218, 230 (2001)). We note that the regulations in question are longstanding, antedating
In the case at hand, the option partners obtained their interests in the purported Tigers Eye partnership by contribution and not by purchase from a transferor partner. Under the regular rule of section 705(a), their outside bases would be determined solely by their purported contributions to the partnership and their shares of the loss and deductions Tigers Eye reported on the partnership return; i.e., determinations that a partnership is required to make. Participating partner premised his claimed inflated basis on (1) treating each purchased option separately from each sold
Assuming without deciding that Helmer would apply if Tigers Eye had been recognized as a partnership for Federal tax purposes, the fact that the obligation to satisfy the sold option might have been contingent does not mean there would have been no deemed distribution to the option partners as a result of the partnership's assumption of the liability. At best, it means the deemed distribution could not be determined until the option was exercised or lapsed and the liability became fixed. Because the option partner could not practicably apply the general rule set forth in section 705(a) and section 1.705-1(a), Income Tax Regs., his basis would have to be determined under the alternative rule by reference to his proportionate share of the adjusted basis of partnership property that would be distributable upon a termination of the partnership. See sec. 1.705-1(b), Income Tax Regs. The property distributed to each option partner was his share of partnership property distributed in liquidation of his interest in the partnership. Thus, had Tigers Eye been recognized as a partnership for Federal income tax purposes, the distribution reported on the Schedule K-1 issued to each option partner would have been the partnership's adjusted basis in the distributed property and would have been the option partner's outside basis in the partnership under the alternative rule.
Pursuant to the second decision paragraph, Tigers Eye is a sham and is not treated as a partnership for Federal income tax purposes. Consequently the option partners were not partners and did not acquire interests in a partnership, they made no contributions to a partnership and received no distributions from a partnership, and there were no items of partnership income, partnership deduction, or partnership loss. Consequently it follows with absolute certainty that there was no outside basis in the partnership. No additional
Therefore, pursuant to section 301.6231(a)(3)-1(c)(3), Proced. & Admin. Regs., the lack of outside basis is a partnership item that we have jurisdiction to decide in the partnership/entity-level proceeding, and we need not revise the stipulated decision.
We have jurisdiction in this proceeding to determine the applicability of any penalty "which relates to an adjustment to a partnership item". Sec. 6226(f); sec. 301.6233-1T(a), Temporary Proced. & Admin. Regs., supra. Therefore, the stipulated decision will exceed our jurisdiction under section 6226(f) if it decides that a penalty applies to an adjustment that does not relate to a partnership item.
In Petaluma II, the Court of Appeals succinctly disposed of the penalties in two paragraphs. First, having accepted the Government's concession that outside basis was not a partnership item, the Court of Appeals reversed the Tax Court's holding that the 40% penalty for gross valuation misstatement applied to the partners' outside bases. The Court of Appeals agreed with Petaluma that "since the Tax Court lacked jurisdiction to determine outside basis, it also lacks jurisdiction to determine that penalties apply with respect to outside basis because those penalties do not relate to an adjustment to a partnership item."
In the second paragraph, the Court of Appeals vacated the Tax Court's Opinion and decision in Petaluma I upholding other accuracy-related penalties
On remand, in Petaluma III this Court observed:
The Court in Petaluma III then fleshed out this observation by elaborating:
The Court in Petaluma III concluded its analysis of Petaluma II as follows:
Under this interpretation, the court of first instance in a partnership-level TEFRA case has jurisdiction to hold that accuracy-related penalties apply only if and to the extent that there are FPAA numerical adjustments to partnership items reported on the partnership return that flow through directly to the returns of the partners so that the adjustments can be given effect directly by computational adjustments and assessments.
As the parties agree, by the second decision paragraph the Court upholds the FPAA's application of the 40% penalty to the portion of any underpayment attributable to a gross valuation misstatement as provided by section 6662(a), (b)(3), (e), and (h), including an underpayment resulting from the overstatement of the option partners' bases in the distributed property. By the third decision paragraph, the stipulated decision determines that the 40% gross valuation misstatement penalty applies to any underpayment of tax attributable to overstating the capital contributions claimed to have been made to the purported partnership.
Underpayments will result from the adjustments reducing the $242,186 loss and the $11,314 deduction to zero and the elimination of the huge losses claimed by the option partners on the sale of the distributed property attributable to overstating the basis in the property. Under Petaluma II as interpreted by Petaluma III we have jurisdiction to determine the applicability of the underpayments related to the adjustments of the loss and other deductions reported on the partnership return. Therefore, we first discuss the application of the penalties to those adjustments.
Participating partner argues that there will be no underpayment attributable to the reduction of the $242,186 loss and the $11,314 of other deductions to zero because the FPAA treats all transactions engaged in by the purported partnership as engaged in directly by its purported partners, so that
First, because Tigers Eye is disregarded as a partnership for Federal income tax purposes, the partners did not have the partnership losses or the partnership deductions that they claimed on their returns. There will be an underpayment of tax from the computational adjustment of those items. The fact that the FPAA treats all transactions engaged in by the purported partnership as engaged in directly by its purported partners does not necessarily mean that the purported partners will be entitled to deduct the losses and expenses. They would not be so entitled if they did not engage in the transactions with a profit motive for purposes of section 165(c)(2), which has been held to disallow losses claimed on option spreads that were entered into for tax avoidance purposes. See Fox v. Commissioner, 82 T.C. 1001 (1984); see also Glass v. Commissioner, 87 T.C. 1087, 1174-1177 (1986), aff'd sub nom. DeWees v. Commissioner, 870 F.2d 21 (1st Cir. 1989).
The computation of the deficiencies attributable to the adjustments of the $242,186 loss and the $11,314 deduction to zero does not require any factual determinations to be made at the partner level, and respondent may assess the deficiencies without issuing a statutory notice of deficiency. Under Petaluma III we have jurisdiction in this partnership-level proceeding to decide the applicability of the accuracy-related penalties that relate to those adjustments.
We first address the 40% gross basis misstatement penalty and then the 20% negligence penalty.
The stipulated decision applies the 40% penalty to the overstatement of "the capital contributions claimed to have been made to the purported partnership". Participating partner asserts that Petaluma II "establishes that any partnership item `elements' of outside basis do not alter the jurisdictional reality that outside basis and any penalties premised on that outside basis remain affected items beyond the scope of a partnership proceeding". Participating partner misconstrues that holding, which addresses the Government's argument that the Tax Court had jurisdiction in the
The alleged capital contributions by the option partners consisted of cash and the pairs of offsetting long and short foreign currency options (option spreads). Tigers Eye claimed the $242,186 loss on the termination or unwinding of the option spreads using the substituted basis of the option partners.
The second decision paragraph upholds the determination in the FPAA that Tigers Eye does not exist and is not a partnership for Federal tax purposes. Pursuant to section 301.6233-1T(c), Temporary Proced. & Admin. Regs., 50 Fed. Reg. 39998 (Oct. 1, 1985), amended, 52 Fed. Reg. 6795 (Mar. 5, 1987), we have jurisdiction in this partnership-level proceeding to determine items of Tigers Eye that would be partnership items if it had been a partnership. As discussed supra, we have jurisdiction to determine the items of Tigers Eye as nominee or agent for the option partners. Therefore, we have jurisdiction to determine Tigers Eye's basis in the option spreads. Because Tigers Eye is disregarded as a partnership, there are no contributions to a partnership. Tigers Eye held the option spreads as nominee or agent and did not acquire the option spreads with a substituted basis (or any
Thus, the disallowance of the $242,186 partnership loss on the unwinding of the option spreads claimed on the partnership return is directly attributable to the reduction of the capital contributions to zero. The overstatement of Tigers Eye's basis in the option spreads (the property claimed to have been contributed to the partnership) is a gross basis misstatement of a partnership item that is attributable to overstating the contributions claimed to have been made to the purported partnership.
The loss claimed by the partnership, which flowed through to the returns of the Logan Trusts and thence to the individual income tax return of Mr. Logan, is attributable to an overstatement of basis of what were claimed to be partnership assets acquired as capital contributions. The 40% gross basis misstatement penalty relates to the adjustment of partnership items, but also the contributions to capital upon which Tigers Eye claimed basis in the option spreads and the loss claimed by Tigers Eye on their unwinding.
The deficiency resulting from the adjustment of the loss and the 40% penalty can be assessed without issuance of a notice of deficiency. Consequently, this Court has jurisdiction under Petaluma II to accept and enter the stipulated decision giving effect to the partnership-level determination that the 40% gross basis misstatement penalty "applies to [the] underpayment of tax attributable to overstating the capital contributions claimed to have been made to the purported partnership." Cf. 106 Ltd. v. Commissioner, 136 T.C. at 74-75.
The fourth paragraph of the stipulated decision provides that the negligence or substantial understatement penalty
We conclude that the third and fourth decision paragraphs, as written, do not overstep the jurisdictional limits of Petaluma II and Petaluma III with respect to the application of penalties to deficiencies related to reducing to zero the $242,186 loss and the $11,314 of other deductions that flowed directly through to the purported partners' returns.
The amounts of the deficiencies and accuracy-related penalties resulting from the adjustments to partnership items of loss and other deductions that flowed through to the purported partners' returns are de minimis in relation to the much larger additional deficiency and 40% penalty that will result from the disallowance of the multimillion-dollar losses claimed by participating partner and the other option partners on the sale of the distributed property (distributed property loss defiency). The huge losses resulted from the option partners' claims that the property was distributed to them in liquidation of their partnership interests and that their bases in the property were the inflated outside bases they claimed
A "substantial valuation misstatement" occurs if the value or the adjusted basis of any property claimed on any return of tax is 200% or more of the correct amount. Sec. 6662(e)(1)(A). The penalty is increased to 40% if the underpayment of tax is the result of a gross valuation misstatement, which is the valuation misstatement determined under section 6662(e) after substituting "400 percent" for "200 percent". Sec. 6662(h)(2)(A).
As the parties agree, by the second decision paragraph the Court upholds the FPAA's application of the 40% penalty to the portion of any underpayment attributable to a gross valuation misstatement as provided by section 6662(a), (b)(3), (e), and (h). By the third decision paragraph, the decision determines that the 40% gross valuation misstatement penalty applies to any underpayment of tax attributable to overstating the capital contributions claimed to have been made to the purported partnership. The parties agree that the stipulated decision applies the 40% gross basis misstatement penalty to the underpayment that will result from the disallowance of the losses the option partners reported on their sales of the distributed property.
Reducing the basis in distributed property from the claimed outside basis to Tigers Eye's cost basis will generate an underpayment. The underpayment relates to adjustments to partnership items — the determination that Tigers Eye is disregarded and is not a partnership for Federal income tax purposes and the resulting overstatement of the contributions claimed to have been made to the purported partnership.
Participating partner acknowledges that the amount of the distributions reported on the partnership return filed by
The disallowed losses claimed on the sale of the distributed property were not the option partners' distributive shares of any loss reported on the partnership return filed by Tigers Eye. Thus, under Petaluma II as interpreted by Petaluma III, we would not have jurisdiction to determine that the accuracy-related penalty applies to the underpayment that will result from the disallowance of that loss. However, we are not bound by that interpretation in this case.
In Petaluma III, this Court was operating under the strict constraints of the law of the case doctrine and the rule of mandate. All Federal Courts of Appeals,
On a remand, the inferior court, to the best of its ability and judgment, must follow and apply the guidance provided by the holdings and clear instructions in dicta of the appellate court. See Gersman v. Group Health Ass'n, Inc., 975 F.2d 886, 896-898 (D.C. Cir. 1992). On remand, the inferior court is also obviously bound under the law of the case by any party concession upon which the appellate court relies in deciding the case and framing the mandate, although that concession would not be binding in another case unless there were a similar concession that was accepted by the court.
In the case at hand, we are not bound by the law of the case and the rule of mandate to follow Petaluma II. However, we have obliged ourselves, under the doctrine of Golsen v. Commissioner, 54 T.C. 742 (1970), aff'd, 445 F.2d 985 (10th Cir. 1971), to follow binding precedent of the Court of Appeals for the D.C. Circuit — to which this case is appealable — which comes only from its holdings in published opinions, see Gersman, 975 F.2d at 897 ("`[w]e are bound only by prior published opinions of this Circuit and not by other means of deciding cases'" (quoting United States v. North, 910 F.2d 843, 881 (D.C. Cir. 1990))), not from dictum that does not "[consider] all the relevant considerations and adumbrates an unmistakable conclusion", see Reich v. Cont'l Cas. Co., 33 F.3d 754, 757 (7th Cir. 1994); cf. Hefti v. Commissioner, 983 F.2d 868, 870-872 (8th Cir. 1993), aff'g 97 T.C. 180 (1991).
In Petaluma II, the Court of Appeals neither affirmed nor reversed the Tax Court's decision that accuracy-related penalties applied; it vacated the Tax Court's Opinion and decision upholding other accuracy-related penalties and remanded the case for further proceedings on that issue. The Court of Appeals could not discern what determination the Tax Court had made regarding the application of accuracy-related penalties. Unfortunately, the Court of Appeals' use of the words "computed", "computation", "computations", and "assessed", in questions it posed regarding how the Court determined the applicability of the penalties to partnership
The questions posed by the Court of Appeals in Petaluma II do not rise to the level of clear dictum that "considers all the relevant considerations and adumbrates an unmistakable conclusion".
The statements of the Court of Appeals in Petaluma II flowed from its holding that the Tax Court did not have jurisdiction to determine that the 40% gross basis misstatement penalty applied to the gross misstatement of outside basis. The Court did not decide the extent of our jurisdiction to determine the applicability of penalties that relate to partnership items. It did not provide any gloss on the phrase "which relates to an adjustment to a partnership item." Nor did it criticize this Court's statement in Petaluma I that the legislative history supports a broad reading of the statute. Consequently, we are not bound to follow our interpretation in Petaluma III of the dicta in Petaluma II that were based on the Government's concession.
The underpayment of tax relates to the adjustment of a partnership item. The underpayment and the 40% penalty can be computed without any factual determinations being made at the partnership level. We conclude that we have jurisdiction to decide that the 40% basis misstatement penalty applies. That conclusion is consistent with Congress' intent and purpose in giving the Tax Court jurisdiction in partnership-level proceedings to determine the applicability of penalties related to the adjustment of partnership items and to relegate the taxpayer to a refund suit in a Federal District Court or the Court of Federal Claims to recover the penalty by proving his reasonable cause/good faith defenses.
We begin with a restatement of the changes Congress made to the TEFRA audit and litigation procedures when it enacted TRA 1997, see supra Part I.B.2 and 3, and will now bring them to bear on the issue at hand. Before the enactment of TRA 1997, penalties and additions to tax (collectively, penalty or penalties) were classified as affected items, and issues regarding such items were litigated in a partner-level affected-items deficiency proceeding following the completion of the partnership-level proceeding. See, e.g., N.C.F. Energy Partners v. Commissioner, 89 T.C. at 744-745; Crystal Beach Dev. of Destin Ltd. v. Commissioner, T.C. Memo. 2000-170. TRA 1997 did not change the classification of penalties as affected items, but it amended section 6221 to provide that the applicability of a penalty "which relates to an adjustment to a partnership item shall be determined at the partnership level". (Emphasis added.) Of particular significance, TRA 1997 also amended section 6230(a)(2)(A)(i) to read as follows:
The change to section 6230(a)(2)(A)(i) deprived a partner of the opportunity to litigate issues concerning the applicability of a penalty that related to an adjustment of a partnership item in an affected-items deficiency proceeding. Therefore, in TRA 1997 Congress added section 6230(c)(1)(C), which allows a partner to file a claim for refund on the ground that "the Secretary erroneously imposed any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item", and amended section 6230(c)(4) by
The TRA 1997 amendments to the TEFRA procedures require that issues regarding the application of penalties be litigated at the partnership level and not in partner-level affected-items deficiency proceedings, as was the case before the effective date of the penalty litigation amendments of TRA 1997. The only qualification that Congress imposed is that the penalty "relate to an adjustment to a partnership item". Secs. 6221, 6226(f), 6230(a)(2)(A)(ii), (c)(1)(C), (4). Congress did not define the word "relate", nor did Congress tie the applicability of the penalty to the existence of a computational adjustment that could be summarily assessed at the end of the partnership-level proceeding.
When Congress enacted the penalty litigation amendments, it was well aware that a partnership-level proceeding under TEFRA does not result in the determination of an underpayment at the partnership level. Underpayments are determined at the partner level after a partnership-level proceeding is completed and/or after an affected-items deficiency proceeding (which occurs if an affected item requires a factual determination at the partner level) is completed. While Congress did not address the mechanics of the application of TEFRA partnership litigation procedures to penalties, it required that penalties that relate to the adjustment of a partnership item be litigated in the partnership-level proceeding and not in an affected-items deficiency proceeding.
In the FPAA issued to Tigers Eye respondent made adjustments to a variety of partnership items and applied the accuracy-related penalty under section 6662(a). Specifically, in the FPAA respondent determined that the partnership was a sham and should be disregarded for Federal income tax purposes. Respondent also adjusted partnership items to zero to reflect that determination (capital contributions, distributions of property other than money, partnership loss, and other deductions). The critical issue under the penalty litigation amendments is whether the penalty in question "relates to adjustments to partnership items". See secs. 6221, 6226(f), 6230(a)(2)(A)(i). Thus we must decide whether the penalties applied in the stipulated decision relate to adjustments to partnership items.
The words "related to a partnership item" take on a peculiar meaning in all Son of BOSS cases, which generally involve the use of a partnership (often transitory) to inflate basis in a partnership asset or the partner's basis in the partnership outside basis. A Son of BOSS transaction generally relies upon and plays off the provisions of subchapter K (sections 701 through 777), and its alleged success depends upon the existence of a partnership. Recognition of the partnership for Federal income tax purposes is a critical integral and necessary element of the transaction. See, e.g., Petaluma I.
Generally, in Son of BOSS cases, there might not be an adjustment to a partnership item that flows directly to a partner's return, and there might not be an item of loss or deduction that a partner reports as a flowthrough item from the partnership to the partnership return to the purported partner's return. Nonetheless, the determination that a partnership that has no economic substance is disregarded and is not a partnership for Federal tax purposes will result in and necessarily require the disallowance of the huge loss claimed on the partner's return from the sale of property purportedly distributed from a partnership. There is a necessary logical and causal relationship between (1) the Commissioner's determination to disregard a partnership that lacks economic substance because it was formed solely to create the illusion of inflated basis in the distributed property and (2) application of the section 6662(h) accuracy-related penalty to the underpayment that results from the disallowance of the loss claimed on the sale of that property that is attributable to the basis overstatement. The penalty relates to the adjustments that result from the Commissioner's determination that the partnership is disregarded for Federal income tax purposes. Under the penalty litigation
Acceptance of the literal and ordinary meaning of "relates to" does not lead to absurd results and would not thwart the obvious purpose of the statute. Thus, we need not adopt a more restrictive interpretation. See Commissioner v. Brown, 380 U.S. 563, 571 (1965).
Congress, in enacting TRA 1997, intended that penalties related to the improper use of illusory partnerships to generate large noneconomic losses be litigated in partnership-level proceedings. Congress did so because the relevant conduct — i.e., the establishment of the partnership, which includes the recording of partner contributions, the establishment of partner capital accounts, and adjustments to those accounts resulting from distributions, assumption of liabilities, and liquidation of a partner's interest — occur largely at the partnership level. In the case of a disregarded partnership, regardless of whether a disallowance of outside basis is at play and regardless of whether outside basis is a partnership item or an affected item, any adjustment at the partner level is preceded by one or more adjustments to partnership items, and a penalty is related to those partnership-level adjustments.
Finally, with respect to the mechanics of TEFRA partnership litigation as it involves penalties, a court with jurisdiction over penalties in a partnership-level proceeding can determine whether the relevant conduct is sufficient to warrant a penalty only in the event that there is an underpayment. The Court does not determine in the partnership/ entity-level proceeding that there is an underpayment or the amount of the underpayment.
This approach is consistent with the approach we are required to take in nonpartnership cases that require Rule 155 computations or in TEFRA litigation where the computational adjustments, and therefore penalty calculations, cannot be made until the parties make the necessary calculations following completion of the partnership-level proceeding.
We see no need to burden the reader with further discussion. For all the reasons summarized in the headnote and set forth at length in the foregoing Discussion, the Court has jurisdiction to determine and the stipulated decision that has been entered holds as follows:
1. that participating partner will have a relatively small deficiency attributable to adjustment of partnership flowthrough items of (a) Loss and (b) Other Deductions, to which the 40% gross basis misstatement penalty and the 20% negligence penalty are respectively applicable; and
2. that participating partner will also have a much larger distributed property loss deficiency attributable to overstating the capital contributions claimed to have been made to the purported partnership; the 40% gross basis misstatement penalty is also applicable to this deficiency.
On the basis of these rulings, as explained in the foregoing Discussion,
An appropriate order will be issued, denying participating partner's motion to revise the stipulated decision.
Reviewed by the Court.
COLVIN, COHEN, HALPERN, and GOEKE, JJ., agree with this opinion of the Court.
GALE and PARIS, JJ., concur in the result only.
FOLEY, J., dissents.
VASQUEZ, GUSTAFSON, and MORRISON, JJ., did not participate in the consideration of this opinion.
HALPERN, J., concurring:
I concur and write separately only to add some small weight to what, in the main, I consider to be a forceful and persuasive analysis by Judge Beghe.
We are a court with nationwide jurisdiction in tax matters alone, and Congress expected that, in so far as we are able to do so, we set precedents for the uniform application of the
Judge Beghe's insight is with respect to the consequence of determining that, for tax purposes, Tigers Eye Trading, LLC (Tigers Eye), is a sham. That of course does not necessarily mean that Tigers Eye was not properly organized as a Delaware limited liability company (L.L.C.), nor does it necessarily mean that it is not a business entity recognized for Federal tax purposes (I assume that Judge Beghe would say: "If in business, its business was acting as nominee and agent for its principals, pertinently, the Logan Trusts."). It does mean, however, that the Logan Trusts (trusts), together with other members of Tigers Eye, did not for Federal income tax purposes join together as partners to invest in currency options so as to cause the trusts' transactions with Tigers Eye (and Tigers Eye's actions on their behalf) to be governed by the substantive provisions of the Internal Revenue Code (Code) governing partners and partnerships; i.e., subchapter K ("Partners and Partnerships"), chapter 1, subtitle A of the Code (subchapter K). Tigers Eye, however, was properly organized as a Delaware L.L.C.; it did receive the currency options from the trusts; it did sell the options, and it did purchase euro and shares of Xerox Corp. (currency and shares, respectively), which it did transfer to the trusts. The trusts, later in the same year, sold the currency and the shares, claiming large losses, which, because of the provisions of the Code governing trusts and their beneficiaries, flowed through to Mr. Logan.
How then are we to explain all of those events (or at least those involving Tigers Eye), and what are the appropriate Federal income tax consequences? Moreover, because Tigers Eye filed a partnership return for 1999 (the year in which most all of the above described events occurred), although we may (and, indeed, shall) disregard the substantive partnership rules in subchapter K because of our finding Tigers Eye to be a sham, we may not disregard the TEFRA procedural provisions applicable to partnership items; i.e., subchapter C ("Tax Treatment of Partnership Items"), chapter 63, subtitle F of the Code (TEFRA procedural provisions). See sec. 6233. We are thus faced with three questions: (1) How to view the series of events between the trusts and Tigers Eye (if not as events between partners and a partnership); (2) what are the
Judge Beghe's answer to the first question is clear and, I believe, correct:
On that basis, Tigers Eye, as agent for the trusts, (1) received the offsetting currency options and cash from the trusts, (2) sold the options (at a loss), and (3) used the bulk of the remaining cash to purchase for the trusts the currency and the shares. For Federal income tax purposes (answering the second question), the trusts (1) realized neither a gain nor a loss on the transfer of the options to Tigers Eye, (2) realized (but may not be allowed) a net loss on Tigers Eye's disposition of the options, and (3) obtained section 1012 cost bases in the currency and the shares upon Tigers Eye's purchase of them for the trusts.
Judge Beghe accurately summarizes section 6233: "Section 6233 provides that if a partnership return is filed for a taxable year but it is determined that no partnership exists, the TEFRA procedures still apply to the entity, its items, and persons holding an interest in the entity, to the extent provided in the regulations." See op. Ct. p. 97. He also accurately summarizes the applicable regulations:
Thus, for instance, if we determine that an entity filing a partnership return is not a partnership but is an association taxable as a corporation, we may determine the amounts taxable to the entity. See sec. 301.6233-1T(a), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6779 (Mar. 5, 1987); see also sec. 301.6233-1(a), Proced. & Admin. Regs. Moreover, the regulations tell us that among our determinations can be the determination that a purported partnership entity (let's call it Tigers Eye Investment Partnership) does not exist. See sec. 301.6233-1T(c), Temporary Proced. & Admin. Regs., supra; see also sec. 301.6233-1(b), Proced. & Admin. Regs. If we find (as the parties agree and the stipulated decision provides) that Tigers Eye Investment Partnership does not exist for Federal income tax purposes, then nothing would have been contributed to it, nothing would have been distributed from it, nor would it, on its own behalf, have engaged in any transactions. That would explain (and justify) the first decision paragraph in the stipulated decision, setting to zero the following adjustments made by the FPAA: Loss, Other Deductions, Distributions of Property Other Than Money, and Capital Contributions. But Tigers Eye, as agent, did receive the offsetting options from the trusts, did sell them, and did purchase for the trusts the currency and the shares. Certainly, as their agent, it had a fiduciary obligation to account to the trusts for the expenditure of their money and to report to them the cost of the property obtained on their behalf.
Section 301.6231(a)(3)-1(c)(3), Proced. & Admin. Regs., illustrates determinations that, with respect to distributions from a partnership, the partnership must make for purposes of its books and records or in order to furnish information to a partner, and which, on that account, constitute partnership items. Among the determinations included is: "The adjusted basis to the partnership of distributed property". Sec. 301.6231(a)(3)-1(c)(3)(iii), Proced. & Admin. Regs.
Tigers Eye, of course, had no basis in the currency and shares it purchased on behalf of the trusts, nor, in the sense contemplated by the regulations, did it make any distribution of that property to them. Nevertheless, because it purchased the property as agent of the trusts, it — rather than the trusts — had the information necessary to determine what property it had purchased for each trust and how much of each trust's money it had expended on those purchases. Those were determinations that Tigers Eye had to make for purposes of its books and records in order to furnish information to the trusts. If we consider Tigers Eye the trusts' agent
I have little to add to Judge Beghe's discussion of the penalties issues. Application of the penalties seems pretty straightforward. Most controversial appears to be application of the gross valuation misstatement penalty to any underpayment of tax attributable to the trusts' overstatements of their bases in the currency and the shares. The trusts' bases in the currency and the shares purchased by Tigers Eye for them are, pursuant to section 1012, the costs of that property, and those costs, in this case, are entity items. The trusts claimed huge losses on the sale of the currency and shares, which, it appears, respondent adjusted down (producing underpayments in tax) simply by substituting their cost bases in the property for their claimed outside bases. There would thus appear to be no partner-level determination required to apply the penalty. By way of analogy, in pertinent part, section 301.6231(a)(6)-1(a)(2), Proced. & Admin. Regs., provides:
In 106 Ltd. v. Commissioner, 136 T.C. 67 (2011), a partnership-level proceeding postdating Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649, we agreed with the parties that a partner-level proceeding was unnecessary to determine a gross valuation misstatement penalty attendant to a partner's sale of foreign currency distributed to him in a nonliquidating distribution. Apparently, the partner's basis in
That would appear to be the case here. The similarity between the two cases is that, as in 106 Ltd., the trusts' bases in the currency and the shares they received is the hypothetical entity's costs of that property (analogous to the partnership's basis in the currency distributed in 106 Ltd.), and respondent may here determine the reduction in the losses reported by the trusts simply by substituting for the trusts' claimed bases in the sold currency and shares their cost bases properly determined in this procedure.
BEGHE, GOEKE, and WHERRY, JJ., agree with this concurring opinion.
WHERRY, J., concurring:
I agree with the results in the opinion of the Court, and the bulk of its analysis. However, I find myself unable to abide by the logic that the opinion deploys to repudiate respondent's gratuitous acknowledgment, in a Status Report filed May 19, 2010: "All parties agree that the basis of each purported partner's interest in Tigers Eye Trading, LLC, is an affected item."
The opinion of the Court characterizes respondent's concession as an issue of law that, if accepted, would deprive us of subject matter jurisdiction. Rejecting it as such, the opinion demonstrates "that the basis of each purported partner's interest in Tigers Eye Trading, LLC, is [not] an affected item", but a partnership item.
The opinion of the Court, pp. 74-75, has marshaled an array of arguments and authorities into an impregnable
Nothing that respondent has said in the Status Report of May 19, 2010, or elsewhere in the record, seeks to deprive us of this jurisdiction. But in exercising this jurisdiction, we cannot avoid confronting the Trojan horse substance latent in respondent's concession: "that the basis of each purported partner's interest in Tigers Eye Trading, LLC, is an affected item."
I concur with the opinion of the Court that there exist good grounds for rejecting this substance. But in my view these grounds lie farther afield of the ones in which the opinion of the Court neatly slays the strawman of litigants stipulating away the Court's subject matter jurisdiction.
Characterizing respondent's concession as an issue of law is problematic for three discrete reasons. First, it implies that respondent is, as it were, recanting in one breath the very regulations he recites with the next.
I agree with the exposition in the opinion of the Court regarding when, under the statute and the regulations, outside basis is properly treated as a partnership item, and disagree with the dissent of Judge Holmes, who would effectively limit such treatment to those partnerships that have made a section 754 election. Judge Holmes' reasoning reads into the statute words that are not there, while reading out of the regulations words that are palpably present.
In explicating the definition of the term "partnership item" in section 6231(a)(3), Judge Holmes' "`starting point * * * [is] the language employed by Congress.'" See Holmes op. p.
The required account-taking action contemplated by section 6231(a)(3) could potentially be incumbent upon, and therefore be undertaken by, only two kinds of account-taking actors: the partnership, which is a nontaxable passthrough entity; and any of its taxable partners. To consider section 6231(a)(3) in its unadorned congressionally enacted glory, we should refrain from circumscribing the required account-taking action it contemplates. Consequently, we should desist from prespecifying either of the two types of potential account-taking actors as the posited performer of the contemplated action. Resisting any such urge, we countenance, as a partnership item, "any item required to be taken into account [by anyone] for the partnership's taxable year under any provision of subtitle A".
Devoid of any constraints on the type of actor required to undertake the envisaged account-taking action, section 6231(a)(3) merely represents an "acquiescing" provision, one that abdicates to the Secretary the nettlesome task of substantively defining a partnership item.
So much for the nonexistent exclusions that Judge Holmes seems to import into the statute. Now, consider the applicable regulatory provisions the full import of which I believe Judge Holmes has overlooked.
The Secretary begins, unsurprisingly, by dutifully noting that his designation of partnership items will comply with the statutorily mandated "more-appropriately-determined" principle. Thus, the Secretary declares that he will designate as partnership items only those items that in his opinion are more appropriately determined at the partnership level. See sec. 301.6231(a)(3)-1(a), Proced. & Admin. Regs. (designating as partnership items those that "are required to be taken into account for the taxable year of a partnership under subtitle
Substantively, that regulation section represents the Secretary's acknowledgment that the account-taking action envisaged in section 6231(a)(3) may be required of either the partnership or any of its partners. Accordingly, he formulates a two-pronged approach for classifying partnership items. One prong constitutes a direct application of the "more-appropriately-determined" principle, while the other prong comprises a recursive application of this principle.
The first of the Secretary's two prongs tackles items required to be taken into account by the partnership. It is almost definitional that any such item is more appropriately determined at the partnership level.
The second prong of the Secretary's two-pronged approach deals with items "required to be taken into account" within the meaning of section 6231(a)(3) — but not by the partnership. It stands to reason that this account-taking could then be incumbent only upon one or more of the partnership's partners. For such an item, the Secretary prescribes a recursive application of the "more-appropriately-determined" principle.
Judge Holmes' analysis fails to confront this recursive application of the "more-appropriately-determined" principle set out in the regulations and, therefore, ignores derivative partnership items.
What does all of this mean for classifying as a partnership item a partner's basis in his partnership interest; i.e., the partner's outside basis? If the partnership is required to account for its partners' outside bases, then under the first
What if the partnership is not required to account for its partners' outside bases? Then, any one partner's outside basis may, or may not, be a partnership item. Outside basis will be a partnership item if it is determined conclusively by partnership items, whether direct or derivative. If all determinants necessary and sufficient to compute outside basis are direct or derivative partnership items, then another recursive application of the "more-appropriately-determined" principle renders the object of their determination, i.e., the outside basis in question, itself a derivative partnership item.
The parsing of the regulations set forth above completely accords with, and perfectly complements, that of the opinion of the Court. But having done the heavy lifting, the opinion of the Court seems to have tripped at the very end. The opinion fails to account for the obvious implication of its own painstaking analysis: Under the regulations, whether outside basis is a partnership item depends upon the facts and circumstances unique and specific to that partnership and partner.
This implication does not lose validity simply because in a partnership-level proceeding we make a finding to disregard the partnership form before us. Disregarding a partnership means we are not respecting the garb in which the taxpayer has dressed up his investment transaction. The mere fact that the form of the investment is not respected, however, does not by itself reduce to zero the amount of the taxpayer's investment that we will recognize for tax purposes.
As shown above, and as the majority itself points out, applying the regulations to establish whether outside basis is an affected item or a partnership item focuses critically on "the extent that a determination of an item relating to a contribution [or a distribution] can be made from * * * determinations that the partnership is required to make". Sec. 301.6231(a)(3)-1(c)(2), Proced. & Admin. Regs. (flush language) (emphasis supplied); see also sec. 301.6231(a)(3)-1(c)(1), Proced. & Admin. Regs. ("The critical element is that the partnership needs to make a determination with respect to a matter for the purposes stated" (emphasis supplied)); sec. 301.6231(a)(3)-1(a)(4), Proced. & Admin. Regs. ("determinations that the partnership is required to make [include those] with respect to an amount, the character of an amount, or the percentage interest of a partner in the partnership, for purposes of the partnership books and records or for purposes of furnishing information to a partner").
Whether or not the (disregarded) partnership before us, Tigers Eye Trading, LLC, is "required", or "needs", to make a determination has to be an issue unique or specific to that given partnership form. Thus, if the regulations are valid, and we are applying them properly, then conceding that outside basis is an affected item here could only mean that this particular partnership entity is not required to make the determinations that will suffice for computing the purported partners' outside bases.
I would portray this "garrulity of advocacy" on respondent's part for what it essentially is — an attempt at stipulating facts. Identifying it as such, I would disregard it because the record shows that it is incorrect.
As the trial court, we enjoy an element of discretion in deciding whether to accept respondent's proffered stipulation. Under Cal-Maine Foods, Inc. v. Commissioner, 93 T.C. 181, 195 (1989) (citing Loftin & Woodard, Inc. v. United States, 577 F.2d 1206, 1232 (5th Cir. 1978), and Jasionowski v. Commissioner, 66 T.C. 312, 317-318 (1976)), "We may disregard stipulations between parties where justice requires it if the evidence contrary to the stipulation is substantial or the stipulation is clearly contrary to facts disclosed by the record." See also Dillon, Read & Co. v. United States, 875 F.2d 293, 300 (Fed. Cir. 1989) (holding that parties remain "free to stipulate to whatever facts they wish, except they may not stipulate to facts known to be fictitious").
I have little hesitation in concluding that the attempted stipulation "is clearly contrary to facts disclosed by the record." Examining the record here, it is readily apparent that the determinants necessary and sufficient for computing the outside bases of Tigers Eye Trading LLC's purported partners were themselves required to be determined at the partnership level. In particular, each outside basis is conclusively determined by a set of determinants comprising the following two kinds of items: (1) the purported partner's distributive shares of Tigers Eye Trading LLC's items of income, gain,
Because the outside basis of each purported partner of Tigers Eye Trading LLC is conclusively determined entirely by partnership items, recursively applying the "more-appropriately-determined" principle under the second prong of the Secretary's two-pronged approach, discussed above, yields a derivative partnership item. I, therefore, have little doubt that respondent's attempt at stipulating facts that render outside basis an affected item is irreconcilable with the facts disclosed by the record.
I am equally confident that justice requires us to disregard the attempted stipulation. Treating outside basis as an affected item of Tigers Eye Trading LLC would preclude us from readjusting the purported partners' inflated outside bases in this partnership-level proceeding. This readjustment would have to await partner-level actions, even though Tigers Eye Trading LLC was required to make all the determinations necessary and sufficient to compute the purported partners' outside bases. Specifically, no additional information would become available for scrutiny at the subsequent partner-level actions that is not forthcoming now in this partnership-level proceeding.
TEFRA, howsoever unwieldy its current practice may have become,
No discussion of accepting or rejecting respondent's concession can be complete without acknowledging and addressing the fact that the Court of Appeals for the D.C. Circuit had, in Petaluma II, accepted a similar concession. Does Golsen tie our hands here and require us to accept respondent's concession regardless of our own analysis of the issue? This is a difficult question, and it bears careful consideration. I submit that we have sufficient latitude to reject respondent's concession without violating the Golsen rule.
At trial in Petaluma I, 131 T.C. 84, the Commissioner never even hinted, much less announced, that outside basis was an affected item of Petaluma, the disregarded partnership at issue in that case. However, on appeal, in Petaluma II, the Commissioner's advocacy took wings, Icarus-like, and soared close to the sun. His speech, and even more, his silence, strongly suggested that the outside bases of Petaluma's purported partners were affected items.
He stated on brief that "A partner's outside basis is generally an `affected item,' rather than a `partnership item'", implying that the purported partners' outside bases in that case were also affected items.
The Court of Appeals seems to have taken this denial at face value. Thus, the court observed that "On appeal the Commissioner concedes that outside basis is not a partnership item in this case." Petaluma II, 591 F.3d at 654 (emphasis supplied). Following this observation, the court seemingly ipso facto "rejected the Tax Court's conclusion that outside basis was a partnership item in this case". Id. at 655
By comparison with the Commissioner's apparently deliberate distance from the issue in Petaluma I, and his "silence as acceptance" of outside bases as affected items in Petaluma II, respondent has left nothing unspoken here. He unequivocally declares that "All parties agree that the basis of each purported partner's interest in Tigers Eye Trading, LLC, is an affected item."
Because we were not confronted with a similar declaration in Petaluma I, the Court was denied the opportunity to develop a record at trial, in sufficient detail, to enable an objective evaluation of the assertion.
Clearly, the Commissioner's subtler, albeit similar, concession was accepted in Petaluma II against a backdrop devoid of any contrary facts established at trial. Consequently, I do not believe Golsen forecloses us from rejecting an unadulterated version of that concession here. Our decision to reject the concession, however, must be supported by sufficient, and sufficiently detailed, findings of fact along the lines outlined above. So long as we do not abuse our discretion and make clearly erroneous factual findings, our rejection should pass muster under a reviewing court's deferential gaze. In sharp contrast, the majority's approach of treating the concession
Relying on the Cal-Maine Foods standards for disregarding factual stipulations, I would tune out respondent's "overzealous advocacy", and instead, turn my ear to the Secretary's much more "parsimonious reasoning". Applying this reasoning to the facts clearly disclosed by the record, the Court should conclude "that the basis of each purported partner's interest in Tigers Eye Trading, LLC, is [not] an affected item", but a partnership item. Accordingly, we should sustain the accuracy-related penalty.
HALPERN, J., agrees with this concurring opinion.
MARVEL, J., dissenting:
In an effort to create order out of the uncertainty regarding our jurisdiction over the section 6662(a) accuracy-related penalty in partnership-level proceedings that was created by Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649 (D.C. Cir. 2010) (Petaluma II), aff'g in part, rev'g in part, vacating in part and remanding 131 T.C. 84 (2008), and Petaluma FX Partners, LLC v. Commissioner, 135 T.C. 581 (2010) (Petaluma III), the opinion of the Court offers an encyclopedic exposition regarding the interrelationship of the partnership provisions
As explained more fully in part II, there is much in the opinion of the Court with which I agree, but its analysis flies in the face of Petaluma III and cannot be reconciled with it. I also disagree that there is an adequate basis for distinguishing Petaluma II. Consequently, for some of the same reasons set forth in Judge Holmes' dissenting opinion, I reluctantly dissent from that part of the opinion of the Court that attempts to distinguish Petaluma II as interpreted and applied in Petaluma III.
Despite my reservations about the effectiveness of the attempt to distinguish Petaluma II as interpreted and applied in Petaluma III, I believe Petaluma III was wrongly decided, but for reasons somewhat different from those the opinion of the Court suggests. I explain these reasons below.
While I understand why the opinion of the Court concludes that outside basis is properly characterized as a partnership item in a case like Tigers Eye Trading, LLC where the partnership is disregarded, I do not believe that our jurisdiction over the section 6662(a) penalty depends upon that conclusion. I believe that we have jurisdiction to sustain the accuracy-related penalty at the partnership level in Son-of-BOSS cases in which we disregard the transitory partnership
Before the enactment of the Taxpayer Relief Act of 1997 (TRA 1997), Pub. L. No. 105-34, sec. 1238, 111 Stat. at 1026, which amended sections 6221, 6226, and 6230 of the TEFRA partnership litigation provisions in the Code, penalties and additions to tax (collectively, penalty or penalties) were classified as affected items, and issues regarding such items were litigated in a partner-level affected item deficiency proceeding following the completion of the partnership-level proceeding. See, e.g., N.C.F. Energy Partners v. Commissioner, 89 T.C. 741, 744-745 (1987). TRA 1997 did not change the classification of penalties as affected items, but it amended section 6221 to provide that the applicability of a penalty "which relates to an adjustment to a partnership item" must be determined at the partnership level. Of particular significance, TRA 1997 also amended section 6230(a)(2)(A)(i) to read as follows:
Because the change to section 6230(a)(2)(A)(i) deprived a partner of the opportunity to litigate issues concerning the applicability of a penalty that relates to an adjustment of a partnership item in an affected items deficiency proceeding, TRA 1997 added section 6230(c)(1)(C) to provide that a partner may file a claim for refund on the ground that "the Secretary erroneously imposed any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item." The House committee report described the
See also S. Rept. No. 105-33, at 261 (1997), 1997-4 C.B. (Vol. 2) 1081, 1341.
The above-described amendments to the TEFRA partnership litigation procedures (collectively, the penalty litigation amendments) changed the landscape of penalty litigation by requiring that issues regarding the application of penalties be litigated in the first instance in the partnership-level proceeding and not in partner-level affected items deficiency proceedings, as was the case before the effective date of the penalty litigation amendments. The only qualifier that Congress imposed is that the penalty relate to an adjustment to a partnership item. Secs. 6221, 6226(f). Congress did not define the word "relate",
When Congress enacted the penalty litigation amendments, it was well aware that a partnership-level proceeding under TEFRA does not result in the determination of an underpayment at the partnership level. Underpayments are calculated at the partner level after a partnership-level proceeding
In the notice of final partnership administrative adjustment (FPAA) issued to Tigers Eye Trading, LLC (Tigers Eye), respondent made adjustments to a variety of partnership items and determined that the accuracy-related penalty under section 6662(a) applied. See op. Ct. pp. 81-85, 140. Specifically, in the FPAA respondent determined that the transitory and illusory partnership involved in the Tigers Eye Son-of-BOSS transaction must be disregarded for Federal income tax purposes. See id. p. 84. Respondent also reduced partnership items to zero to reflect that determination (capital contributions, distributions of property other than money, and other items). See id. p. 81. Each one of those adjustments was directly attributable to and was the result of the determination that the transitory and illusory partnership in Tigers Eye Trading, LLC must be disregarded for Federal income tax purposes.
The analysis in the opinion of the Court illustrates in considerable detail that the relationship requirement imposed by section 6221 and referenced in section 6230(a)(2)(A)(i) is satisfied in Tigers Eye Trading, LLC. See id. pp. 103-109, 112-119, 123, 126-127. The section 6662(a) penalty clearly relates to respondent's determinations to disregard the Tigers Eye partnership and to zero out specific partnership items such as contributions and distributions allegedly made by the purported partnership to the purported
It helps to put the discussion regarding the impact of the penalty litigation amendments on our penalty jurisdiction in TEFRA partnership litigation in context, and the opinion of the Court does that very well. The Tigers Eye Son-of-BOSS transaction relied upon and played off of the provisions of subchapter K (sections 701 through 777), and the anticipated tax benefits that the transaction was supposed to generate depended upon the existence of a valid partnership. Recognition of the partnership for Federal income tax purposes was essential to the success of the Son-of-BOSS transaction as a tax shelter.
There is a logical and causal relationship between respondent's determination to disregard a partnership without economic substance, his determination to adjust other partnership items, such as contributions and distributions, to zero, and his determination to impose the section 6662(a) accuracy-related penalty. All of the adjustments relate to and flow from respondent's determination that the partnership is disregarded for Federal income tax purposes, and the determination to impose the accuracy-related penalty flows directly from and relates to the determination to disregard the transitory and illusory partnership. Under the penalty litigation amendments, that is all that Congress required for the penalty to be litigated in the partnership-level proceeding.
Whether or not outside basis is at play (and, if so, whether outside basis is an affected item or in narrow circumstances a partnership item) should not control our resolution of whether we have jurisdiction to decide in a partnership-level proceeding whether the section 6662(a) penalty applies. What does control our resolution of the issue is whether the penalty relates to the adjustment of a partnership item. Absent any guidance from Congress regarding the meaning of the word "relates", I, like the opinion of the Court, answer the question in the affirmative. The imposition of the section
If the "relate to adjustments to partnership items" language of section 6230(a)(2)(A)(i) is narrowly construed to mean only a numerical adjustment of an item on a partnership return that flows through to the partners' returns and results in computational adjustments to the partners' tax liabilities at the end of the partnership proceeding, such an interpretation, I submit, would effectively repeal the penalty litigation amendments with respect to many, if not most, partnerships because the computation of the underpayment of the partners' tax liabilities must await the completion of affected items deficiency proceedings. I do not believe that is what Congress intended when it enacted the penalty litigation amendments.
Congress intended that in modern tax shelters involving partnerships, penalties related to the improper use of an illusory partnership as a mechanism for generating large noneconomic losses should be litigated in the partnership-level proceeding. Congress did so because the relevant conduct, i.e., the establishment of the partnership, which includes the recording of partner contributions, the establishment of partner capital accounts, and adjustments to those accounts resulting from distributions, assumption of liabilities, and liquidations, occurs largely at the partnership level. Cf. H.R. Rept. No. 105-148, supra at 594, 1997-4 C.B. (Vol. 1) at 916. In the case of a disregarded partnership, regardless of whether a disallowance of outside basis is at play and regardless of whether outside basis is a partnership item or an affected item, any adjustment at the partner level is preceded by one or more adjustments to partnership items, and the section 6662(a) penalty relates to those partnership-level adjustments.
GALE and PARIS, JJ., agree with part II of this dissent.
HOLMES, J., dissenting:
It is customary and appropriate for us to reconsider an issue after being reversed by a circuit court, and stick to our position if we think it right. But only if the case we use to reaffirm ourselves is appealable to a different circuit. When, as unfortunately we do today, we brazenly challenge the D.C. Circuit's precedent in Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649 (D.C. Cir. 2010) (Petaluma II), aff'g in part, rev'g in part and remanding in part 131 T.C. 84 (2008) (Petaluma I), in a case appealable to that court we risk being seen as impudent. We also risk not even getting that court to reconsider — the D.C. Circuit treats its published opinions as stare decisis for later panels, see, e.g., Sierra Club & Valley Watch, Inc. v. Jackson, 648 F.3d 848, 854 (D.C. Cir. 2011), so what we are really asking is for the parties to appeal and then petition for en banc reconsideration.
Before today, our Court recognized the importance of circuit-court precedent. In our landmark decision in Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff'd, 445 F.2d 985 (10th Cir. 1971), we held "that better judicial administration requires us to follow a Court of Appeals decision which is squarely in point where appeal from our decision lies * * * to that court alone." (Fn. ref. omitted.) Golsen tells us not to bang our head against contrary appellate precedent, and we've consistently held that we must follow the precedent of the court that has appellate jurisdiction over a case. See Bergmann v. Commissioner, 137 T.C. 136, 146 (2011) ("Because this case is appealable to the * * * Ninth Circuit, we follow that court's precedent"); Wechsler & Co. v. Commissioner, T.C. Memo. 2006-173 ("[U]nder the doctrine of Golsen * * * we must apply [Second Circuit] precedents * * * to the extent that they contradict our precedents").
I'll begin with an analysis of why the majority's maneuver around the precedent it's bound to follow is bound to fail, and then move on to an active defense of that precedent. For not only do I believe Golsen requires us to follow Petaluma II in this case; I believe the D.C. Circuit got it right both on the question of whether outside basis is a partnership item, and on the limits of our jurisdiction over penalties at the partnership level.
Before we hinted in a footnote in Countryside Ltd. P'ship v. Commissioner, T.C. Memo. 2008-3 n.4, that we might begin to view things differently, we had consistently held that outside basis was generally an affected item.
In Petaluma FX Partners, LLC v. Commissioner, 135 T.C. 581 (2010) (Petaluma III), we tried to comply with the D.C. Circuit's mandate in Petaluma II. That decision is so recent that the appeal from it is still under submission. Yet the majority in this case offers up essentially two theories as to why we don't have to follow Petaluma II and Petaluma III in this case. It argues that
I begin by looking at the merits of these arguments. I also ask whether it's up to us, as a trial court, even to make them.
The majority assumes that Petaluma II's holding was dictated by the Government's concession on appeal that outside basis was an affected item. But parties can't concede that a court has subject matter jurisdiction over a case; a court has to decide that for itself. See, e.g., NAACP v. New York, 413 U.S. 345, 353 (1973); Mondy v. Sec'y of the Army, 845 F.2d 1051, 1055 (D.C. Cir. 1988) (defendant's concession regarding jurisdiction didn't matter to court's jurisdictional analysis); McGowan v. Commissioner, 67 T.C. 599, 607 (1976). And because the D.C. Circuit's jurisdiction over outside basis depended on ours, the Government's concession on appeal didn't bind the D.C. Circuit and was irrelevant to its jurisdictional analysis.
This jurisdictional question is a question of law. Courts are never bound by a concession on appeal as to a question of law, see, e.g., United States v. Ginyard, 444 F.3d 648, 649, 651-652 (D.C. Cir. 2006), so if the D.C. Circuit really did accept an erroneous concession of jurisdiction, it would have committed a reversible error. I just don't believe that to be the case.
Even assuming arguendo that the D.C. Circuit relied upon the Government's concession at all, that court also gave an additional reason for holding that outside basis was an affected item under the plain language of section 6231(a)(3).
The majority also reasons that "[b]ecause the Court of Appeals did not consider the regulation in concluding in Petaluma II that outside basis is an affected item, * * * its decision on the outside basis issue in Petaluma II has been superseded by the intervening opinions of the Supreme Court in Mayo Found. and the Court of Appeals in Intermountain." See op. Ct. p. 112. Here is the real beginning of our trouble. It's not plausible to read Petaluma II as just a mistake caused by the D.C. Circuit overlooking the regulation the majority relies on when there's a simpler reading of that opinion: The D.C. Circuit construed the Code itself to make outside basis an affected item — the low-hanging forbidden-fruit metaphor implies that if an item is not more appropriately determined at the partnership level or is not an item with respect to a partnership's own tax year, it is not a partnership item. Petaluma II, 591 F.3d at 655. Even if determining it would be really, really easy at the partnership level.
The majority asserts that Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. ___, 131 S.Ct. 704 (2011), and Intermountain Ins. Serv. of Vail, LLC v. Commissioner, 650 F.3d 691 (D.C. Cir. 2011), rev'g 134 T.C. 211 (2010), somehow changed the legal landscape that the court relied on in Petaluma II. I disagree. In Mayo Found., the Supreme Court held that courts must apply Chevron's two-step framework (rather than the multifactor test of National Muffler) to analyze the validity of regulations. See id. at ___, 131 S. Ct. at 713-714. That wasn't, however, new law in the D.C. Circuit — it had been applying Chevron deference to regulations at least since 2003, well before either Petaluma II or Mayo Found. See Tax Analysts v. IRS, 350 F.3d 100,
It's not even true that the D.C. Circuit overlooked the regulation: A glance at Petaluma II shows that the court cited section 301.6231(a)(3)-1, Proced. & Admin. Regs. In fact, it cited the regulation three times. Petaluma II, 591 F.3d at 650, 653. But the majority infers from the D.C. Circuit's failure to construe the section of the regulation that deals with distributions and contributions, section 301.6231(a)(3)-1(a)(4) and (c), Proced. & Admin. Regs., that it did not consider that regulation in reaching its holding that outside basis was an affected item. It's more reasonable to conclude that it just didn't read the regulation the way the majority here does today. Fighting the D.C. Circuit's holding in Petaluma II is hard enough, but fighting it with an argument that the court missed the relevant regulation — when it actually cited it — will probably prove less than entirely persuasive.
The majority's reliance on Intermountain is also misplaced. In Intermountain, the D.C. Circuit held that old Code section 275(c) was ambiguous and that Congress added language to section 6501(e)(1)(A) to resolve the ambiguity. See id. at 701-702. It also held that Colony, Inc. v. Commissioner, 357 U.S. 28 (1958), only dealt with the interpretation of old section 275(c), and didn't unambiguously foreclose the new regulation applying new section 6501(e)(1)(A). Intermountain, 650 F.3d at 703-704. The court then, as Chevron requires, analyzed the text of the relevant Code section and the reasonableness of the regulation. See id. at 704-710.
Nothing new here either. In neither this case nor Petaluma is there anything like the problem created by Colony — a precedent that predates a regulation and might affect its validity. And Petaluma II interpreted the very same TEFRA regulations that we are dealing with here. Colony, in contrast, did not interpret the regulations at issue in Intermountain; it was relevant only to the question of whether the Code section in that case was ambiguous. The majority here cannot reasonably use Intermountain to disregard Petaluma II's interpretation of the TEFRA regulations.
What the majority is really arguing is that if only the D.C. Circuit knew about its more elaborate argument, it would surely overrule Petaluma II. The rule for Article III courts in
I can think of no reason for our relation with the appellate courts that review our work to be any different.
Even if we weren't climbing such a towering mountain of contrary authority, I'd still be skeptical of the majority's analysis. Absent a few very limited exceptions, the Code and regulations make outside basis an affected item.
"[O]ur starting point must be the language employed by Congress." Reiter v. Sonotone Corp., 442 U.S. 330, 337 (1979). Section 6231(a)(3) says:
The majority boils it down to this: "A partnership item is an item that is (1) required to be taken into account under any provision of subtitle A, governing income taxes, and (2) identified by the Secretary in the regulations as `more appropriately determined at the partnership level.'" See op. Ct. p. 98. The majority's reconstructed definition, however, leaves out an important phrase.
Look at the first part of section 6231(a)(3) — "[W]ith respect to a partnership, any item required to be taken into account for the partnership's taxable year under any provision of subtitle
The phrase is no accident — "partnership's taxable year" is a defined term, see sec. 706, and "partnership's taxable year" or "partnership taxable year(s)" appears in twenty or so Code sections.
We must read section 6231(a)(3) in pari materia with section 706. "We can only take the Code as we find it and give it as great an internal symmetry and consistency as its words permit." United States v. Olympic Radio & Television, Inc., 349 U.S. 232, 236 (1955). The phrase "partnership's taxable year," read this way, limits the substantive reach of the Code's definition of a "partnership item." A partnership item has to have something to do with the partnership's (and not, by implication, just with the partners') tax year. That's why section 301.6231(a)(3)-1(a), Proced. & Admin. Regs., says that a partnership item is an item that is "required to be taken into account for the taxable year of a partnership" under any income tax provision of the Code.
That leads me to my next point — section 6231(a)(3) also says that a partnership item isn't a partnership item unless a regulation makes it one. But that section adds yet one
What the majority is missing is that the Commissioner didn't expressly conclude it is more appropriate to determine outside basis at the partnership level than at the partner level. The Code doesn't say that a partnership item is defined by the certainty with which a factfinder can determine it from what he knows at the partnership level.
The majority's attack on Petaluma II will succeed or fail, though, on the strength of its interpretation of the regulations defining partnership and affected items. Section 301.6231(a)(5)-1(b), Proced. & Admin. Regs., defines affected items, and provides that "[t]he basis of a partner's partnership interest [(i.e., outside basis)] is an affected item to the extent it is not a partnership item." One might reasonably read this as stating a general rule that outside basis is an affected item, but with a few exceptions. The majority, however, enthusiastically finds a great many instances where outside basis is a partnership item. Cataloging them all, one finds that the majority would hold outside basis to be a partnership item when
Thus, the first problem with the majority's result: It's usually not a good reading when the exception swallows all but a bit of the tail of the general rule.
Stranger things have happened in tax law — but probably not here. The regulation itself lists one exception to the general rule that outside basis is an affected item: "Optional adjustments to the basis of partnership property pursuant to an election under section 754 (including necessary preliminary determinations, such as the determination of a transferee partner's basis in a partnership interest)." Sec. 301.6231(a)(3)-1(a)(3), Proced. & Admin. Regs. This makes sense. The reason outside basis is a partnership item when a partnership makes a section 754 election is that such a partnership itself needs to determine its partners' outside bases to redetermine the partnership's own inside basis for the "partnership's taxable year."
This specific exception has, of course, nothing to do with this case because Tigers Eye never made a section 754 election.
But that's not exactly what the regulation says. Section 301.6231(a)(3)-1(a)(4), Proced. & Admin. Regs., goes like this:
I acknowledge that section 301.6231(a)(3)-1(a)(4), Proced. & Admin. Regs., is less than a model of clarity — it doesn't just say that contributions to, and distributions from, a partnership are partnership items. It says "items relating to" them are — but only "to the extent that a determination of such items can be made from determinations that the partnership is required to make * * * for purposes of the partnership books and records or for purposes of furnishing information to a partner." (Emphasis added.)
In the very first paragraph of section 301.6231(a)(3)-1(a), Proced. & Admin. Regs., however, the regulation unequivocally states that all the items it lists as partnership items are "required to be taken into account for the taxable year of a partnership under subtitle A." We can't just ignore this language. That's why in Hambrose Leasing 1984-5 Ltd. P'ship v. Commissioner, 99 T.C. 298, 311 (1992), we held:
We also held that for something to be a partnership item under the regulation, it has to at least have an "effect on the partnership, its books and records, or [some] other aspect of the partnership." Id. Likewise, in Dakotah Hills Offices Ltd. P'ship v. Commissioner, T.C. Memo. 1996-35, we held:
In Petaluma I we did change course and relied on Allen Family Foods, Inc. v. Commissioner, T.C. Memo. 2000-327. We claimed in Petaluma I that Allen Family Foods supported the idea that "[s]ection 301.6231(a)(3)-1(c)(2) and (3), Proced. & Admin. Regs., provides that partnership items include determinations that relate to contributions and distributions to the extent that those determinations do not require information that is outside the Court's jurisdiction." Petaluma I, 131 T.C. at 99. We then reasoned that since
Allen Family Foods, however, only repeated the language in the temporary regulation, and held that we lacked jurisdiction in a corporate-level proceeding to decide the amount of the shareholder's basis in an S corporation. Allen Family Foods, T.C. Memo. 2000-327. This is a strong hint that our reliance on Allen Family Foods in Petaluma I was seriously misplaced.
The majority, however, makes no mention of these pre-Petaluma I cases. And although I agree that a partnership must determine certain items — partnership items such as contributions and distributions — so that the partner can figure out his basis in the partnership, Tigers Eye itself was
Odder still is the majority's invocation of Chevron. See op. Ct. pp. 124-126. Having misconstrued the regulation, the majority moves on to defend its validity — something which no one has challenged before. The most troubling part of the majority's analysis on this seemingly superfluous subject is its assertion that "the Secretary considered the treatment of partnership items in a detailed and reasoned fashion before making a final decision." See op. Ct. p. 125.
In explaining the regulations at the time of their publication, however, the Secretary gave no hint that he regarded outside basis as a partnership item under section 301.6231(a)(3)-1(a)(4) and (c), Proced. & Admin. Regs., absent a section 754 election. See 51 Fed. Reg. 13212, 13213 (Apr. 18, 1986). There's certainly nothing like the majority's analysis — that if contributions and distributions are partnership items, outside basis must be a partnership item too. Instead, the explanation straightforwardly reasons that where a partnership makes a section 754 election, "[t]he determination of the transferee partner's basis in his partnership interest is a partnership item because that determination is necessary in order for the partnership to make certain partnership-level determinations with respect to the transferee partner's basis in partnership property." Id. (emphasis added).
Even more tellingly, before our decision in Petaluma I, the Internal Revenue Manual (IRM) said that outside basis was generally an affected item:
The clarity of the old IRM on this point suggests that the majority's Chevron analysis actually serves to undermine the validity of the regulation as the majority construes it. For in section 6231(a)(3), Congress made it clear that the Secretary can't just make any item a partnership item — he can only make an item a "partnership item" if it is
The first of these requirements is the most glaring problem for the majority. Apart from peculiar cases like partnerships that make section 754 elections or partnerships that hold partnership interests in other partnerships, a partnership does not have to take outside basis into account for its own tax year. If the majority's reading of the regulation is correct, there really would be a problem with its validity because it would conflict with the requirement that an item be taken into account for the taxable year of a partnership. See Chevron, U.S.A., Inc. v. Natural Res. Def. Council, 467 U.S. 837, 842-843 (1984) (an agency "must give effect to the unambiguously expressed intent of Congress").
There would also be a problem because of the Code's other requirement. Section 6231(a)(3) tells the Secretary that he must determine that an item is more appropriately determined at the partnership level to list it as a partnership item in the regulations. Other than in the case of a partnership's section 754 election, there is no evidence in section 301.6231(a)(3)-1, Proced. & Admin. Regs., that the Secretary made this finding for outside basis. And I don't believe that
The majority never grapples with these problems, and certainly never pins them down.
The majority's challenge to Petaluma II is not limited to the question of whether outside basis is a partnership item. It also goes after Petaluma II's analysis of our jurisdiction over penalties in partnership-level cases.
Section 6226(f) says that we have jurisdiction at the partnership level to determine "the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item." The fundamental problem in defining our jurisdiction over penalties at the partnership level is that imposing a penalty requires an underpayment of tax from which the penalty can be computed. An underpayment is generally the difference between the correct income tax determined by the IRS and the amount stated by the taxpayer on his return. See sec. 6664(a). It's axiomatic that partners, not partnerships, pay tax. This makes it hard to distinguish penalties that relate to partnership items from penalties that don't, since penalties ultimately are calculated on underpayments, which isn't something partnership returns generate by themselves.
In Petaluma II, the D.C. Circuit interpreted section 6226(f)'s grant of jurisdiction much more narrowly than the majority does today. It declined to allow the finding that a partnership was a sham to confer on us jurisdiction at the
In Petaluma III we interpreted the D.C. Circuit's mandate to mean that "if the penalty does not relate directly to a numerical adjustment to a partnership item, it is beyond our jurisdiction." Petaluma III, 135 T.C. at 587.
Overruling Petaluma III on jurisdiction over penalties would be understandable if it were only a side effect of our reaffirmation of Petaluma I that outside basis is a partnership item. But the majority says that even if it is wrong about outside basis, we would still have jurisdiction to determine the applicability of penalties relating to it. The majority opines that "[i]n the case of a disregarded partnership, regardless of whether a disallowance of outside basis is at play and regardless of whether outside basis is a partnership item or an affected item, any adjustment at the partner level is preceded by one or more adjustments to partnership items, and a penalty is related to those partnership-level adjustments." See op. Ct. p. 142. This conclusion rests on the opinion's broad interpretation of "relates to" in section 6226(f), a construction that has been rejected by both the D.C. and Federal Circuits.
This counsels against a broad construction of "relates to." In TEFRA world, there's generally no partnership-level jurisdiction over affected items even though we know by definition that all affected items "relate to" partnership items — they couldn't be affected items if they weren't affected by determinations of partnership items. See sec. 6231(a)(5). But if we hold that all penalties relating to affected items are also "penalt[ies] * * * relate[d] to an adjustment to a partnership item," we would have to conclude Congress wanted this Court to determine the applicability of penalties for all affected item adjustments at the partnership level. Sec. 6226(f). This would be unreasonable because adjustments to the affected items themselves don't get determined until partner-level proceedings, and it's usually only in Wonderland, see Lewis Carroll, Alice's Adventures in Wonderland 109 (Oxford Univ. Press 2009) (1865), or in the more unpleasant judicial systems around the world that "penalty first — verdict afterwards" is the rule.
Note especially the Code's use of the word "adjustments" instead of "determinations" in section 6226(f). We have usually interpreted "adjustment" to mean a numerical increase or decrease. See Southern v. Commissioner, 87 T.C. 49, 55 (1986) (construing "adjustment" in section 702(a)(7)); see also S. Rept. No. 105-33, at 254 (1997), 1997-4 C.B. 1081, 1334 ("An adjustment determined to be correct would thus have the effect of increasing the taxable income that is deemed to have been reported on the taxpayer's return"); Staff of J. Comm. on Taxation, General Explanation of the Tax Legislation Enacted in 1997, at 370 (J. Comm. Print 1997). All adjustments are determinations, but not all determinations are adjustments. This distinction helps explain the line that the D.C. Circuit drew in Petaluma II between penalties that "could have been assessed without partner-level computations" and penalties that could not. Petaluma II, 591 F.3d at 656. The majority implies that determining that a partnership is a sham is an adjustment to a partnership item but doesn't explain why. See, e.g., op. Ct. pp. 135, 140. Petaluma II agreed that the determination that a partnership is a sham is a determination of a partnership item, but it did not hold that it was an adjustment.
The majority, however, tries to get around this by reasoning that the penalties also relate to the adjustments to contributions and distributions made in the FPAA. See op. Ct. pp. 140-142. These determinations certainly were adjustments — contributions and distributions were reduced to zero. But do the penalties that the Commissioner asserts "relate to" these adjustments? The Government made a very similar argument in Jade Trading, LLC v. United States, 98 Fed. Cl. 453, 460 (2011) (Jade Trading III), aff'd, 451 Fed. Appx. 954 (Fed. Cir. 2012), contending that a finding that a partnership was a sham permitted the application of penalties without regard to the partners' outside bases because it caused Jade Trading's inside basis in the spread transaction to be reduced to zero. Id. But the court disagreed:
The Government also argued that misstating the basis to the partnership of property that the partners contributed (i.e., inside basis) — which undoubtedly is a partnership item, see sec. 301.6231(a)(3)-1(a)(4), Proced. & Admin. Regs. — also made the penalties based on misvaluation related to adjustments to partnership items. But the court rejected this argument too because the Government had not "demonstrated that any understatement of tax * * * resulted from the contribution." Id. And the court frowned upon the Government's attempt to "focus on these contributions in isolation * * * and then use these contributions, standing alone, to trigger penalties." Id.
I do agree with the majority that the amount of the underpayment of tax can't be determined at the partnership level — it's determined in a notice of computational adjustment or a notice of deficiency proceeding at the partner level. Yet unlike the majority, I believe that we have jurisdiction at the partnership level only over penalties that relate directly to numerical adjustments to partnership items. See Petaluma III, 135 T.C. at 587. More specifically, the penalty must relate to a partnership-item adjustment that seems capable of being summarily assessed as a computational adjustment.
In conclusion, I believe that we shouldn't challenge the D.C. Circuit on the issue of our partnership-level jurisdiction over penalties any more than we should challenge it on the
I'll stand a safe distance off to one side, and respectfully dissent.
THORNTON and KROUPA, JJ., agree with part I of this dissent.
In Tigers Eye I respondent also contended that Curtis Mallet Prevost Curt & Mosle (Curtis Mallet) — the law firm that issued the tax opinion on which Mr. Logan and participating partner claim to have relied in taking their 1999 Federal income tax return positions — was a promoter of the transaction. In Tigers Eye I we also expressed the view that this promoter contention raised a partnership-level issue that the Court could address at the trial; we also set forth our views on the legal standard for determining promoter status. In 106 Ltd. v. Commissioner, 136 T.C. 67, 77-81 (2011), the Court, notwithstanding that in Tigers Eye I we had expressed those views in dicta, adopted and applied those views in holding that the law firm that had issued the tax opinion in the Son of BOSS transaction in that case was a promoter of the transaction whose opinion could not be reasonably relied upon in good faith by the partnership or the taxpayer.
Tigers Eye I concluded with an Afterword that deplored the inefficiency and waste of judicial and party resources caused by the apparent splitting of the accuracy-related penalty cause of action under TEFRA as amended by TRA 1997. That inefficiency and waste are exemplified by the motions we have had to deal with in Tigers Eye I and by the continuing controversies in Petaluma, the case at hand, and other Son of BOSS cases over whether the accuracy-related penalties must or can be determined at the partnership level or the partner (individual taxpayer) level.
We noted in Tigers Eye I that the IRS has initiated a response to the observed problems, relying on its authority under sec. 6231(c) to promulgate regulations with respect to special enforcement areas if it determines that treating certain items as partnership items under TEFRA will interfere with the effective and efficient enforcement of the revenue laws. The IRS has proposed regulations, Notice of proposed rulemaking, sec. 301.6231(c)-9(c), Proposed Proced. & Admin. Regs., 74 Fed. Reg. 7205 (Feb. 13, 2009), which, when and if promulgated, would enable the Commissioner to convert partnership items to nonpartnership items in partnership cases involving listed transactions; invoking this procedure would have the salutary effect of providing for "one-stop shopping" through application of the traditional deficiency procedures to both deficiencies and accuracy-related penalties in such transactions. See 1 William S. McKee et al., Federal Taxation of Partners and Partnerships, para. 10.02[4], at 10-16 (4th ed. 2007). We also noted that the proposed regulations would not provide relief in the case at hand or the myriad other pending Son of BOSS cases. The proposed regulations have not been finalized.
SCHEDULE K OTHER INCOME (LOSS) STATEMENT 1DESCRIPTION AMOUNT NONPORTFOLIO SHORT-TERM CAPITAL GAIN (LOSS) 5,354 INTEREST INCOME 1,617 WITHDRAWAL FEES 8,700 ORDINARY LOSS FROM SEC. 988 TRANSACTIONS -257,857 _________ TOTAL TO SCHEDULE K, LINE 7 -242,186 SCHEDULE K OTHER DEDUCTIONS STATEMENT 2DESCRIPTION AMOUNT OPERATING EXPENSES 11,314 _________ TOTAL TO SCHEDULE K, LINE 11 11,314 =========
The importance of the 40% penalty to both the IRS and taxpayers in Son of BOSS cases is shown by the repeated attempts by taxpayers to use concessions to take the penalty out of play. See, e.g., Bergmann v. Commissioner, 137 T.C. 136 (2011), and Chief Counsel Notice CC-2012-001 (Oct. 5, 2011), opposing the allowance of concessions to avoid imposition of valuation misstatement penalties. See 199 Daily Tax Rept. (BNA) K-6 (Oct. 14, 2011). In a status report filed November 13, 2009, in the case at hand respondent provided a list, with docket numbers, of more than 40 Son of BOSS cases pending in the Tax Court in which respondent was asserting both sec. 465 at risk (as an alternative position) and the 40% gross basis misstatement penalty. In a previous filing, respondent had asserted that the aggregate amount of the 40% penalties being asserted in such cases amounted to approximately $130 million, of which the 40% penalties in five still-pending Sentinel-promoted Son of BOSS cases amounted to approximately $41 million.
Both the House conference report and the so-called Blue Book accompanying TEFRA use the term "partnership item" in discussing pre-TEFRA law with no indication that the term's connotation would undergo a qualitative transformation as a consequence of the enactment of TEFRA. To the contrary, both reports advance, as a primary motivation for enacting TEFRA, the consistent tax treatment of any one partnership item across all partners in the same partnership.
The House conference report, H.R. Conf. Rept. No. 97-760, at 62 (1982), 1982-2 C.B. 600, 662, notes that under "present law", i.e., before the enactment of TEFRA, "partnerships are not taxable entities[;] * * * partnerships are required to file an annual information return[;] * * * [but] adjustments are made to each partner's income tax return". (Emphasis supplied.) The report bemoans the fact that as a result of the foregoing, "a judicial determination of an issue relating to a partnership item generally is conclusive only as to those partners who are parties to the proceeding." Id. (emphasis supplied). In discussing how TEFRA would "promote increased compliance and more efficient administration of the tax laws", the report comments that pursuant to TEFRA, other than certain limited exceptions, "the tax treatment of any partnership item is to be determined at the partnership level". Id. (emphasis supplied).
The Blue Book, Staff of the Joint Committee on Taxation, General Explanation of the Revenue Provisions of the Tax Equity and Fiscal Responsibility Act of 1982, at 267 (J. Comm. Print 1982), repeats the language quoted above. In addition, the Blue Book observes that before enactment of TEFRA, "Duplication of manpower and administrative and judicial effort was required in some cases to determine the aggregate tax liability attributable to a single partnership item. Inconsistent results could be obtained for different partners with respect to the same item." Id. at 268 (emphasis supplied).
Assume arguendo that an item required to be taken into account by the partnership is nonetheless not considered more appropriately determined at the partnership level. Because this item is required to be taken into account by the partnership, it may, indeed quite possibly will, play a definitive role in the partnership-level proceeding. However, because it is not considered more appropriately determined at the partnership level, the item will be beyond the purview of the partnership-level proceeding. Thus, the partnership-level proceeding will remain unresolved until the item in question is conclusively determined — presumably at the partner level. But the latter itself cannot commence until the partnership-level proceeding has been concluded. Such a perverse perpetual loop could bring TEFRA's elaborate administrative and judicial machinery to a grinding halt.
To see how transitivity enables a recursive application of the "more-appropriately-determined" principle, begin by considering an item, "Item A", that is conclusively determined by several ("n") different determinations that the partnership is required to make, call them (A
Now, consider another item, "Item B", that is conclusively determined by the aggregate set of: (1) several ("m") different determinations that the partnership is required to make, call them (B
The same would apply for yet another item, "Item C", that is conclusively determined by the aggregate set of: (1) several ("p") different determinations that the partnership is required to make, call them (C
By comparison with the partner-specific adjustments to the basis of partnership property under sec. 743(b), sec. 734(b) provides for adjustments to the common basis of partnership property. These adjustments are triggered by certain kinds of partnership distributions and are made to the partnership's undistributed property.
Specifically, the adjustments apply following any distribution in which the distributee partner either recognizes gain or loss or receives the distributed property with a basis different from that of the partnership before the distribution. See sec. 734(b)(1) and (2). Both contingencies, the distributee partner's recognizing gain or loss and his receiving the distributed property with a different basis, would require the partnership to account for the distributee partner's outside basis to ascertain the sec. 734(b) adjustment. See generally sec. 731 (governing distributee partner's recognition of gain or loss); sec. 732 (providing rules for determining distributee partner's basis in the distributed property); sec. 733 (specifying adjustments to distributee partner's outside basis). As with sec. 743(b) adjustments, basis adjustments under sec. 734(b) are now no longer entirely elective. Effective for distributions after October 22, 2004, adjustments to the partnership's undistributed property are required, not only if the partnership has a sec. 754 election in effect, but also if "there is a substantial basis reduction with respect to such distribution." Sec. 734(a).
This could also be the case if an individual contributes built-in loss personal use property for business use by the partnership. Under Au v. Commissioner, 40 T.C. 264 (1963), aff'd, 330 F.2d 1008 (9th Cir. 1964), the partnership would take a basis in the contributed property in the amount of: (1) its fair market value at the time of contribution, or (2) its adjusted basis in the contributing partner's hands, whichever is lower. See also sec. 1.167(g)-1, Income Tax Regs. ("In the case of property which has not been used in the trade or business or held for the production of income and which is thereafter converted to such use, the fair market value on the date of such conversion, if less than the adjusted basis of the property at that time, is the basis for computing depreciation."). If the contributed property had a built-in loss at the time of contribution, then the partnership will receive the property with a fair market value basis. The partnership will presumably have no reason to keep track of the contributing partner's historical cost basis in the contributed property. However, under sec. 722, the contributing partner's basis in his partnership interest should be his adjusted basis in the contributed personal use property.
The same result can obtain even for contributions of business use property if the partnership does not maintain "book capital accounts" in accordance with the capital account maintenance rules of sec. 1.704-1(b)(2)(iv), Income Tax Regs. Assume, for simplicity, that the partnership determines each partner's distributive share of income, gain, loss, deduction, or credit "in accordance with the partner's interest in the partnership" under sec. 704(b). If a partner contributes either personal use or business use property with a built-in loss to such a partnership, for the partnership's business use, then under sec. 704(c)(1)(C)(ii), the partnership will take a fair market value basis in the contributed property. The contributed property's "built-in loss shall be taken into account only in determining the amount of items allocated to the contributing partner". Sec. 704(c)(1)(C)(i). Once the partnership no longer holds the property, say as a result of a distribution to a partner other then the contributing partner, the partnership will presumably have no reason to keep track of the contributing partner's historical cost basis in the contributed property.
Finally, an individual or corporate partner may be required to readjust its basis in its partnership interest under various provisions of the Code for reasons unrelated to changes in the partnership's operations. The partnership would ordinarily have no reason to keep track of such readjustments. Examples of such readjustments include the following.
An insolvent partner may reduce the basis of his partnership interest (along with that of other unrelated assets he owns) under sec. 108(b), which demands tax attribute reduction as the price for the insolvency exclusion of cancellation of indebtedness income. Unless the partner's insolvency affects, or arises from, operations of the partnership, the latter will have no reason to keep track of such a basis reduction under sec. 108(b).
A corporate partner may adjust its basis in its partnership interest for the "recapture" imposed by sec. 1363(d) and sec. 1.1363-2, Income Tax Regs., which provide a "look-through rule" for certain partnership inventory upon the tax-free contribution of a partnership interest from a C corporation to an S corporation. Note that the partnership's accounting remains unaffected unless it specifically elects to adjust the basis of the inventory at issue, pursuant to sec. 1.1363-2(e), Income Tax Regs. This election is different from, and not covered by, a sec. 754 election.
Outside basis would become relevant in this readjustment calculus if a purported partner of a disregarded partnership claims on his tax return a loss on the sale of property, the basis of which is derived from his claimed outside basis in the disregarded partnership. Such property could be the purported partner's claimed partnership interest, or (as here) property other than money received in a claimed liquidation distribution. In either case, the conceptual nullity of outside basis would not by itself allow us to readjust down to zero the basis of such sold property. Surely we would not ignore any actual cash, in U.S. dollars (the functional currency for a U.S. taxpayer), that the purported partner had invested in the partnership, merely because we are ignoring the partnership form. Thus, if the purported partner had purchased his claimed partnership interest from a third party, his purchase price would not evaporate and become a tax nullity, even though his outside basis does so, as a consequence of disregarding the partnership. In any sale of the claimed partnership interest, or of the property other than money received in a claimed liquidating distribution, the purported partner would still be allowed to recover tax free the amount of his actual purchase price; i.e., the underlying transactions would be treated as engaged in by the purported partner directly.
A 40% penalty applies under sec. 6662(a), (e) and (h) "to any portion of an underpayment of tax required to be shown on a return, if * * * the adjusted basis of any property * * * claimed on any return of tax imposed by chapter 1 is * * * [400] percent or more of the amount determined to be the correct amount of such * * * adjusted basis". Such property here is the "property (other than money) distributed by a partnership to a partner in [a claimed] liquidation of the partner's interest". Sec. 732(b). Because no money was included in the claimed liquidating distribution, "The basis of [such] property * * * shall be an amount equal to the adjusted basis of such partner's interest in the partnership". Id.
Since outside basis is a partnership item here, we can sustain a readjustment down to zero of each purported partner's interest in the disregarded partnership. The basis in the hands of a purported partner of property other than money received in a claimed liquidation distribution is conclusively determined by determinations that the partnership is required to make and "the adjusted basis of such partner's interest in the partnership". Id. The presumption of transitivity of determinations renders the basis of the claimed liquidating distribution more appropriately determined at the partnership level, and therefore, a partnership item. See supra note 12. Hence, we can sustain readjusting the basis of the claimed liquidating distribution down to equal the readjusted outside basis of zero. The resulting valuation misstatement is "gross" enough to sustain the 40% penalty.
