101 T.C. 365">*366 COLVIN, Judge: Respondent determined a $ 21,268 deficiency in petitioners' Federal income1993 U.S. Tax Ct. LEXIS 66">*67 tax for 1983 and increased interest for substantial underpayment due to taxmotivated transactions.

After concessions, the issues for decision are;

1. Whether the period for assessment of tax for partnership items provided in section 6229 applies to items which arose in years for which assessment of tax is otherwise barred by section 6501(a). We hold that it does;

2. whether the notice of deficiency is barred by res judicata or as a second notice for the same year under section 6212(c). We hold that it is not;

3. whether petitioners may deduct a $ 120,000 partnership loss for Regal Laboratories, Ltd. We hold that they may not;

4. whether petitioners are liable for increased interest for substantial underpayment due to tax-motivated transactions under section 6621(c). We hold that they are.

References to petitioner in the singular are to Lee C. Boyd. Section references are to the Internal Revenue Code in effect in 1983. Rule references are to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

1. Petitioners

Petitioners are husband and wife who resided in Wilton, Connecticut, when they filed their petition.

1993 U.S. Tax Ct. LEXIS 66">*68 2. Regal Laboratories, Ltd.

Regal Laboratories, Ltd. (Regal), was a limited partnership formed in Nevada to commercially exploit various agricultural biotechnologies, including a product known as Agrosoke. Four promoters began selling Regal limited partnership units in May 1983. Shirley Bailey, M.D. (Dr. Bailey), was Regal's general partner in 1983 and 1984. Each limited partnership unit cost $ 10,000, consisting of $ 2,000 in cash and an $ 8,000 promissory note. The partnership promised investors a deduction equal to five times their cash investment in the first year. Petitioners' cash investment in Regal was $ 24,000 in 1983.

101 T.C. 365">*367 A Federal grand jury investigated Regal in 1985 and concluded that the partnership did not engage in any business. The grand jury found that the promoters embezzled or misappropriated most of the money the limited partners invested. In 1985 the promoters were indicted on charges of conspiracy, mail fraud, wire fraud, interstate transportation of stolen property, and securities fraud. The promoters pled guilty. Regal did not file a partnership return for 1983. On October 16, 1986, respondent prepared a substitute return for Regal's 1993 U.S. Tax Ct. LEXIS 66">*69 1983 taxable year pursuant to section 6020(b).

3. The First Notice of Deficiency

Petitioners filed their 1983 Federal income tax return on April 16, 1984. They claimed a $ 13,361 medical expense deduction and a $ 120,000 partnership loss.

Respondent issued two notices of deficiency to petitioners for 1983. Respondent mailed a notice of deficiency on June 2, 1987, for 1983 (first notice of deficiency) in which respondent disallowed the $ 120,000 partnership loss and other deductions. Respondent did not issue the first deficiency notice within the time allowed for assessment of tax by section 6501.

Petitioner timely filed a petition in the Tax Court on September 3, 1987. That case was docket No. 29725-87. In that case, the parties stipulated that petitioner was not liable for a deficiency in income tax for 1983. The Court entered a decision based on that stipulation on October 28, 1988.

4. The TEFRA Proceeding

After Congress enacted the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, sec. 402(a), 96 Stat. 648, respondent conducted an audit of Regal under the TEFRA unified partnership audit provisions (TEFRA partnership provisions). Secs. 1993 U.S. Tax Ct. LEXIS 66">*70 6221-6233. Respondent disallowed Regal's deduction for research and development for 1983, which respondent calculated to be $ 10 million. On June 20, 1988, respondent issued a notice of final partnership administrative adjustment (FPAA) to Dr. Bailey, the partnership's tax matters partner (TMP). Respondent sent copies of the FPAA to the notice partners on June 20, 1988. The parties stipulated that petitioner was a notice partner because he owned 1.2 percent of the partnership. Secs. 6223, 6231(a)(8). 101 T.C. 365">*368 However, petitioner did not receive a copy of the FPAA and did not find out about the TEFRA partnership proceeding until February 6, 1991.

Regal's TMP did not file a petition with the Tax Court. However, Green Valley Land & Cattle Co., Inc. (Green Valley), a notice partner, did. That case was docket No. 30329-88. The Tax Court entered a decision under Rule 248(b) on July 23, 1990, in which Green Valley conceded the $ 10 million research and development expense deduction.

5. The Second Notice of Deficiency

Respondent first mailed petitioners a copy of the FPAA and notice of commencement of the TEFRA partnership proceeding on February 6, 1991. At that time, respondent1993 U.S. Tax Ct. LEXIS 66">*71 invited petitioners to elect to have the Court's decision apply to them. Sec. 6223(e)(2). Petitioners did not respond to the offer.

Respondent issued a second notice of deficiency to petitioners (second notice of deficiency) on June 7, 1991, in which respondent disallowed petitioners' claimed $ 120,000 partnership deduction and $ 6,089 of petitioners' claimed $ 13,361 medical deduction.

OPINION

1. Introduction

The primary issue for decision is whether the second notice of deficiency for 1983, resulting from the TEFRA partnership audit of Regal, is valid. Petitioners contend it is invalid because, in a prior notice of deficiency for 1983, respondent untimely determined that petitioners were not entitled to certain deductions relating to Regal. Petitioners believe it is grossly unfair to subject them to a second notice of deficiency for 1983.

The analysis of this issue requires consideration of the TEFRA partnership provisions, sections 6221 to 6233. The TEFRA partnership provisions were enacted in 1982 in response to the mushrooming administrative problems experienced by the Internal Revenue Service in auditing returns of partnerships, particularly tax shelter partnerships1993 U.S. Tax Ct. LEXIS 66">*72 with numerous partners. Staff of Joint Comm. on Taxation, General Explanation of the Revenue Provisions of the Tax Equity and Fiscal Responsibility Act of 1982, at 268 (J. 101 T.C. 365">*369 Comm. Print 1982). Under these procedures, the tax treatment of partnership items is determined at the partnership level in a unified partnership proceeding rather than in separate proceedings for each partner. Id. As we stated in an earlier case interpreting the TEFRA partnership procedures:

By enacting the partnership audit and litigation procedures, Congress provided a method for uniformly adjusting items of partnership income, loss, deduction, or credit that affect each partner. Congress decided that no longer would a partner's tax liability be determined uniquely but "the tax treatment of any partnership item [would] be determined at the partnership level." Sec. 6221. [Maxwell v. Commissioner, 87 T.C. 783">87 T.C. 783, 87 T.C. 783">787 (1986); alteration in original.]

2. Whether Assessment of Tax Relating to Petitioners' Regal Partnership Deduction Is Barred by the Statute of Limitations

Petitioners contend that section 6501(a) bars assessment of tax relating to their Regal deduction1993 U.S. Tax Ct. LEXIS 66">*73 for 1983. We disagree with petitioners because assessment of tax relating to their Regal partnership deductions is governed by the TEFRA partnership provisions, not by the general deficiency procedures under which petitioners' first notice of deficiency for 1983 was issued. Petitioners' $ 120,000 Regal deduction was not properly included in the first notice of deficiency. Sec. 6225(a); 87 T.C. 783">Maxwell v. Commissioner, supra.As we said in 87 T.C. 783">Maxwell v. Commissioner, supra at 787-788:

In drawing the line between those matters which may be the subject of a partnership proceeding and those which may not be, the statute divides disputes arising from "partnership items" from disputes arising from "nonpartnership items." * * * If the tax treatment of a "partnership item" is at issue, the statute requires the matter to be resolved at the partnership level. Sec. 6221. * * *

* * *

It is evident both from the statutory pattern and from the Conference report that Congress intended administrative and judicial resolution of disputes involving partnership items to be separate from and independent of disputes involving nonpartnership items. 1993 U.S. Tax Ct. LEXIS 66">*74 Consequently, the portion of any deficiency attributable to a "partnership item" cannot be considered in the partner's personal case involving other matters that may affect his income tax liability. The "partnership items" must be separated from the partner's personal case and considered solely in the partnership proceeding. See sec. 6226(a); sec. 6226(f).

101 T.C. 365">*370 Income tax must generally be assessed within the later of 3 years after the return is filed or the due date of the return. Sec. 6501(a) and (b). However, section 6501(a) does not apply to income tax attributable to partnership items. Sec. 6501(o); Cambridge Research & Dev. Group v. Commissioner, 97 T.C. 287">97 T.C. 287, 97 T.C. 287">292 (1991). Regal's losses are partnership items.

Income tax attributable to partnership items must generally be assessed within 3 years after the later of the date the partnership files its information return or the due date of the partnership return. Sec. 6229(a); 97 T.C. 287">Cambridge Research & Dev. Group v. Commissioner, supra.Regal did not file a 1983 return. Respondent may assess tax attributable to a partnership or affected item at any time if the1993 U.S. Tax Ct. LEXIS 66">*75 partnership has not filed a return. Sec. 6229(c)(3). A substitute return is not a partnership return for statute of limitations purposes. Sec. 6229(c)(4). Therefore, the FPAA issued to Dr. Bailey on June 20, 1988, was timely.

Treatment of TEFRA partnership items is determined at the partnership level rather than in separate proceedings involving individual partners. Secs. 6221, 6222, and 6223; Sente Inv. Club Partnership v. Commissioner, 95 T.C. 243">95 T.C. 243, 95 T.C. 243">247-248 (1990); Maxwell v. Commissioner, 87 T.C. 783">87 T.C. 787. Regal was a TEFRA partnership for 1983. A partner owning more than a 1-percent interest in a partnership generally is a "notice partner". Sec. 6223(b). Respondent must mail to notice partners, at their correct address, notice of when the administrative proceeding under section 6223(a) begins and ends. Sec. 6223(a), (d); Wind Energy Technology Associates III v. Commissioner, 94 T.C. 787">94 T.C. 787, 94 T.C. 787">788 (1990).

Petitioner was a notice partner because he owned a 1.2-percent interest in Regal. Petitioner did not receive timely notice as required under section 6223(a), and respondent has not asserted1993 U.S. Tax Ct. LEXIS 66">*76 proper mailing of the notice. Regal's partnership action in the Tax Court had become final when petitioner received notice. In that situation, a taxpayer may elect to be treated consistently with the decision or may elect out of the partnership proceeding. Sec. 6223(e)(2)(B); Aufleger v. Commissioner, 99 T.C. 109">99 T.C. 109, 99 T.C. 109">114 (1992). Petitioner did not elect to be subject to the partnership proceeding. Therefore, petitioners' deduction of the $ 120,000 Regal loss was converted to a nonpartnership item on February 6, 1991, the day respondent mailed notice of the proceeding to petitioner. 101 T.C. 365">*371 Secs. 6223(e)(2)(B), 6231(b)(1)(D); 94 T.C. 787">Wind Energy Technology Associates III v. Commissioner, supra at 793; sec. 301.6223(e)-2T(a)(2), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 6785 (Mar. 5, 1987).

Respondent generally must assess any tax attributable to converted nonpartnership items within 1 year from the date the items become nonpartnership items. Sec. 6229(f). Under section 6229(f), respondent had until February 6, 1992, to issue the notice of deficiency with respect to the Regal deduction. ¹ Respondent1993 U.S. Tax Ct. LEXIS 66">*77 mailed the second notice of deficiency to petitioners on June 7, 1991. Thus, we conclude that the second notice of deficiency was timely and assessment with respect to the claimed $ 120,000 Regal loss is not barred by the statute of limitations. Sec. 6229(f).

3. Second Notice of Deficiency Not Invalid Under the Doctrine of Res Judicata

Petitioners argue that the doctrine of res judicata bars respondent's assessment of their 1983 partnership items because our decision in docket No. 29725-87 was also for 1983. Respondent stipulated in that decision that petitioner was not liable for a deficiency in income tax or additions to tax for 1983 because the period of limitations on assessment and collection had expired.

1993 U.S. Tax Ct. LEXIS 66">*78 The doctrine of res judicata bars litigating a claim if it was or could have been litigated in a prior case. Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591, 333 U.S. 591">597-598 (1948); Trost v. Commissioner, 95 T.C. 560">95 T.C. 560, 95 T.C. 560">566 (1990). As discussed above, petitioners' $ 120,000 partnership loss deduction was not properly included in the first notice of deficiency. Maxwell v. Commissioner, 87 T.C. 783">87 T.C. 788. The first notice of deficiency was invalid, id., and the decision entered was a nullity, ²Billingsley v. Commissioner, 868 F.2d 1081">868 F.2d 1081, 868 F.2d 1081">1084-1085 (9th 101 T.C. 365">*372 Cir. 1989), revg. an order of this Court. Thus, litigation of the claimed $ 120,000 partnership loss is not barred by res judicata.

1993 U.S. Tax Ct. LEXIS 66">*79 4. Second Notice for 1983 Not Invalid Under Section 6212(c)

Petitioners argue that section 6212(c) precludes respondent from issuing a second notice of deficiency to petitioner for 1983. Section 6212(c) provides in pertinent part:

SEC. 6212(c). FURTHER DEFICIENCY LETTERS RESTRICTED. --

(1) GENERAL RULE. -- If the Secretary has mailed to the taxpayer a notice of deficiency as provided in subsection (a), and the taxpayer files a petition with the Tax Court within the time prescribed in section 6213(a), the Secretary shall have no right to determine any additional deficiency in income tax for the same taxable year * * * with respect to any act (or failure to act) to which such petition relates, except in the case of fraud, and except as provided * * * in section 6213(b)(1) (relating to mathematical or clerical errors) * * *