T.C. Memo. 2009-192



                      UNITED STATES TAX COURT



 LKF X INVESTMENTS, LLC, LKF X CAPITAL CORPORATION, TAX MATTERS
                     PARTNER, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6492-06.               Filed August 25, 2009.



     Edward M. Robbins, Jr., and Sharyn M. Fisk, for petitioner.

     David W. Sorensen, for respondent.



                        MEMORANDUM OPINION


     MARVEL, Judge:   Respondent issued a notice of final

partnership administrative adjustment (FPAA) for 2001, pursuant

to section 6223(a),1 to LKF X Capital Corp. (LKF CC or


     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code (Code), and all Rule references are to
                                                   (continued...)
                              - 2 -

petitioner), the tax matters partner of LKF X Investments, L.L.C.

(LKF), a limited liability company classified as a partnership

for Federal income tax purposes.2   LKF CC timely filed a petition

contesting respondent’s determinations.

     This matter is before the Court on the parties’ motions for

summary judgment under Rule 121.    The issues for decision are:

(1) Whether the Court has jurisdiction in this partnership-level

proceeding to decide whether LKF should be disregarded for

Federal income tax purposes and whether the partners’ outside

bases are zero; (2) whether the Court has jurisdiction to decide

whether the accuracy-related penalties apply; and (3) if the

Court has jurisdiction regarding the accuracy-related penalties,

whether LKF is liable for the substantial valuation misstatement

prong of the accuracy-related penalty.

     For the reasons discussed below, we shall deny petitioner’s

motion for summary judgment and grant respondent’s motion for

summary judgment.


     1
      (...continued)
the Tax Court Rules of Practice and Procedure.
     2
      Respondent determined in the FPAA that LKF was a sham,
lacked economic substance, and should be disregarded for Federal
income tax purposes. Our references to LKF as a partnership and
to its members as partners are for convenience only.

     LKF is not a small partnership within the meaning of the
small partnership exception, see sec. 6231(a)(1)(B)(i), and
therefore is subject to the unified partnership audit and
litigation procedures of the Tax Equity and Fiscal Responsibility
Act of 1982, Pub. L. 97-248, sec. 402(a), 96 Stat. 648.
                                - 3 -

                              Background

     The parties stipulated the relevant facts for purposes of

our ruling on the motions.    We incorporate their stipulations

herein by this reference.    No facts material to the disposition

of the cross-motions remain in dispute.

I.   The Market-Linked Deposit Transactions

     A.   Preliminary Steps

     On or before September 26, 2001, Laurence K. Fishman (Mr.

Fishman) engaged the law firm of Cantley and Sedacca, L.L.P.

(Cantley), to prepare and file all documents necessary for the

formation of LKF and LKF CC.    Between September 26 and October

17, 2001, Cantley prepared and sent Mr. Fishman documents to

enable Mr. Fishman to participate in market-linked deposit

transactions (MLD transactions) Cantley promoted.3

     On September 26, 2001, LKF was formed as a limited liability

company under the laws of Delaware.     On the same day Mr. Fishman

executed an operating agreement of LKF X Investments, L.L.C.

(operating agreement), acknowledging that Mr. Fishman contributed

$130,000 in exchange for 100,000 class A units of LKF.    Upon

LKF’s formation, Mr. Fishman was its only member.4    The operating


     3
      Cantley instructed Mr. Fishman to sign the documents but
not date them. Mr. Fishman signed the documents as instructed
and returned them to Cantley in September 2001.
     4
      On Sept. 26, 2001, LKF filed a Form SS-4, Application for
Employer Identification Number, identifying LKF as a multiple-
                                                   (continued...)
                                - 4 -

agreement identified Venice, California, as LKF’s principal

office and place of business.

     On September 26, 2001, LKF CC was incorporated under the

laws of Delaware; the certificate of incorporation identified

Edward Sedacca as the incorporator.     On September 27, 2001, in

his capacity as the sole shareholder of LKF CC,5 Mr. Fishman

elected himself as the sole director of LKF CC.     On the same day,

as the sole member of the board of directors, Mr. Fishman elected

himself president and secretary-treasurer and adopted the bylaws

of LKF CC.

     On September 26, 2001, LKF opened a broker account at

Deutsche Banc Alex. Brown, L.L.C.   At some point before

October 1, 2001, $130,000 was deposited into LKF’s account.




     4
      (...continued)
member limited liability company and Mr. Fishman as its manager.
The Form SS-4 showed that Los Angeles County, California, was
LKF’s principal business location.
     5
      The record indicates that as of Sept. 27, 2001, Mr. Fishman
had not transferred any property to LKF CC in exchange for its
stock. The record is not clear whether any LKF CC shares
nevertheless had been issued to Mr. Fishman at that point that
would have allowed Mr. Fishman to properly elect LKF CC’s
directors on Sept. 27, 2001. See Del. Code Ann. tit. 8, sec. 107
(2001) (providing generally the incorporator elects the first
directors and adopts the original bylaws). However, the validity
of Mr. Fishman’s vote as a shareholder on Sept. 27, 2001, does
not affect our resolution of the parties’ motions.
                               - 5 -

     B.   The Terms of the MLD Transactions

     On October 17, 2001, LKF and Deutsche Bank AG New York

(Deutsche Bank)6 entered into two offsetting MLD transactions.

The terms of the MLD transactions required LKF and Deutsche Bank

to deposit the same amount,   21,978,022, with each other.    Both

deposits had a maturity date of December 18, 2001, and fixed

interest at an annual rate of 3.6 percent, payable at maturity

along with the principal.

     The terms of the MLD transactions also provided for bonus

coupons payable on December 18, 2001, but only if at 10 a.m. New

York time on December 14, 2001 (bonus coupon fixing date), the

Japanese yen to U.S. dollar exchange rate was greater than or

equal to a certain exchange rate (strike price).7   With respect

to the deposit by LKF, Deutsche Bank was to pay LKF a   3,516,484

bonus coupon if the strike price was greater than or equal to

125.15 Japanese yen to a U.S. dollar (long option).   With respect

to the deposit by Deutsche Bank, LKF was to pay Deutsche Bank a




     6
      The parties stipulated that Deutsche Bank was the
counterparty to the transactions. Although Deutsche Bank sent
the confirmations of the transactions, the confirmations also
indicate that Deutsche Bank London was the counterparty. In any
case, for purposes of the parties’ motions it is irrelevant which
Deutsche Bank entity entered into the transactions.
     7
      For both MLD transactions Deutsche Bank was the calculation
agent that would determine and notify the parties of the exchange
rate on the bonus coupon fixing date.
                                 - 6 -

 3,477,802 bonus coupon if the strike price was greater than or

equal to 125.17 Japanese yen to a U.S. dollar (short option).

     Under the terms of the MLD transactions, LKF was to pay

Deutsche Bank a premium of    2,197,802, or $2 million at a spot

rate of 0.91, and Deutsche Bank was to pay LKF a premium of

 2,173,626, or $1,978,000 at a spot rate of 0.91.    The terms of

the long and short options provisions of the MLD transactions are

summarized below:

                               Strike price
  Option       Premium        per U.S. dollar     Bonus coupon
  Long        2,197,802            ¥125.15          3,516,484
  Short       2,173,626             125.17          3,477,802
                 1
    Net            24,176                              38,682

     1
      The U.S. dollar equivalent of the net premium was $22,000
at the exchange rate of 0.91 U.S. dollar per euro.

The parties agreed to pay the premiums on October 19, 2001,8 but

neither LKF nor Deutsche Bank transferred the deposit amounts or

the premiums to the other party.    On October 25, 2001, LKF wired

a $22,000 net premium to Deutsche Bank.

     Under the bonus coupon provisions of the MLD transactions,

three scenarios were possible.    If on the bonus coupon fixing

date the exchange rate was below 125.15 Japanese yen to a U.S.

dollar, neither LKF nor Deutsche Bank would be entitled to a

premium interest payment.    If the exchange rate was 125.15 or


     8
      The parties incorrectly stipulated that the premium for the
long option was payable on Oct. 16, 2001, instead of Oct. 19,
2001.
                                 - 7 -

125.16 Japanese yen to a U.S. dollar, LKF would be entitled to a

 3,516,4849 bonus coupon and would have no obligation to pay a

bonus coupon to Deutsche Bank.    If the exchange rate was at or

above 125.17 Japanese yen to a U.S. dollar, both LKF and Deutsche

Bank would be entitled to receive and would be required to pay

bonus coupons, meaning that LKF would be entitled to a net bonus

coupon of    38,682.10

     C.     Events After October 17, 2001

     On October 18, 2001, Mr. Fishman entered into an agreement

with CF Advisors XVI, L.L.C. (CF Advisors),11 according to which

CF Advisors was to advise Mr. Fishman on investment strategies

using long and short foreign currency and foreign currency

derivatives.    On October 19, 2001, Mr. Fishman, in his capacities

as the sole member of LKF and the president of LKF CC, executed

an assignment of membership units and joinder agreement

(assignment agreement) transferring his entire interest in LKF to

LKF CC.   Mr. Fishman treated the transaction as a nontaxable

exchange under section 351 in which Mr. Fishman contributed to



     9
      The parties’ stipulation of fact 24 incorrectly shows this
amount as 3,156,484.
     10
      The potential net bonus coupon is calculated as the
difference between the bonus coupons payable, or 3,516,484 minus
 3,477,802.
     11
      The parties incorrectly stipulated the name of the CF
Advisors entity; we disregard the stipulation on this point as
being inconsistent with the record.
                                 - 8 -

LKF CC property with a $2,130,000 basis in exchange for LKF CC

shares.12

     On October 29, 2001, CF Advisors became a member of LKF

when LKF CC and CF Advisors executed an amended and restated

operating agreement of LKF X Investments, L.L.C. (amended

agreement).   In the amended agreement LKF CC and CF Advisors

acknowledged that LKF CC contributed $130,00013 in exchange for

99,000 class A units and CF Advisors contributed $2,000 out of

service fees described below in exchange for 1,000 class B units.

The members agreed that LKF would be classified as a partnership

for Federal income tax purposes.    See sec. 301.7701-3(a) and

(b)(1), Proced. & Admin. Regs.    On the Form 1065, U.S. Return of

Partnership Income, the parties reported the transaction as a



     12
      Although the parties stipulated that Mr. Fishman received
1,000 LKF CC shares in exchange for interest in LKF, a document
entitled “IRC Section 1.351-3(a) Statement for Shareholder 2001
Tax Year”, attached to Mr. Fishman’s 2001 Form 1040, U.S.
Individual Income Tax Return, indicates that Mr. Fishman received
100,000 voting common shares of LKF CC. LKF CC’s certificate of
incorporation indicates, however, that only 10,000 common shares
were authorized when LKF CC was incorporated. The discrepancies
in the record as to the number of LKF CC shares that Mr. Fishman
received in a sec. 351 transaction do not affect our disposition
of the motions.
     13
      The long option and $130,000 were assets LKF held when it
was a single-member limited liability company, and therefore
technically LKF CC contributed both cash and the long option to
the newly created partnership with CF Advisors, as stipulation 79
states (and as reported on LKF’s Form 1065, U.S. Return of
Partnership Income). However, for reasons that are not explained
in the record, the amended agreement does not mention the long
option as a capital contribution by LKF CC.
                                 - 9 -

contribution to LKF of $2,130,000 consisting of $130,000 cash and

$2 million of MLD transactions, and by CF Advisors of $2,000.

LKF CC’s capital contribution item of $2 million represented the

 2,197,802 premium, converted to U.S. dollars at the spot rate of

0.91, that LKF was to pay Deutsche Bank under the terms of the

long option.     The parties did not reduce the basis in LKF to

reflect the obligations under the short option, taking a position

that those obligations were not liabilities for purposes of

section 752.

     The amended agreement also provided that CF Advisors would

provide services as an investment adviser and foreign currency

and foreign currency derivatives specialist.     The amended

agreement provided for quarterly compensation of CF Advisors for

such services calculated on the basis of LKF’s net asset value

and all income and gains.    With respect to 2001, however, the

parties agreed CF Advisors would receive a one-time $8,000

service fee.14    On November 8, 2001, LKF wired $6,000 to CF

Advisors’ account in partial payment of the service fee for 2001.

     Between November 9 and 21, 2001, LKF entered into four

separate European digital currency option transactions with



     14
      The stipulation of facts contains conflicting information
regarding the amount of the service fee. On the one hand,
stipulated Exhibit 21-J states that the fee was $8,000, and we so
find. On the other hand, the parties stipulated in par. 39(g)
that the fee was $20,000. In any event, the amount of the fee is
not determinative.
                              - 10 -

Deutsche Bank involving euro, Japanese yen, British pounds, and

Canadian dollars (digital options) for a premium of $2,000 each.

On November 16, 2001, LKF sold the Japanese yen digital option

for $2,835.   On November 26, 2001, LKF wired an $8,000 payment

for the digital options premiums to Deutsche Bank.    The three

remaining digital options expired, with the euro and Canadian

dollar digital options expiring out of the money and the British

pound digital option paying $3,478.    The aggregate net loss to

LKF with respect to the digital options was $1,687.    On December

10, 2001, LKF authorized a purchase of Canadian dollars for

$1,000 (Canadian currency position) at the spot rate.

     On December 18, 2001, the MLD transactions matured.    Neither

LKF nor Deutsche Bank repaid each other the principal or fixed

interest.15

     D.   LKF’s Deemed Liquidation

     On December 20, 2001, CF Advisors withdrew as a member of

LKF by selling its interest to LKF CC for $2,000; LKF CC became

LKF’s sole member after the sale.    Because LKF had elected to be

treated as a partnership for Federal tax purposes, the sale of CF

Advisors’ interest resulted in a deemed liquidation of LKF for


     15
      The record does not reflect what exchange rate the
calculation agent reported on the bonus coupon fixing date, but
the parties stipulated that the New York Federal Reserve Bank
reported the exchange rate of 127.38 Japanese yen per U.S.
dollar. The record does not reflect that the parties paid each
other bonus coupons or that Deutsche Bank paid a net bonus coupon
to LKF.
                               - 11 -

Federal income tax purposes.   See sec. 708(b)(1)(A); McCauslen v.

Commissioner, 

, 592 (1966); Rev. Rul. 99-6, 1999-1

C.B. 432, 433.   On December 20, 2001, LKF’s assets consisted of

$101,015 cash and the Canadian currency position.   Under section

732(b) LKF CC claimed a basis in the Canadian currency position

equal to its basis in LKF, or $2,001,000.

      On or about December 24, 2001, LKF sold the Canadian

currency position for $878.07.16

II.   Federal Income Tax Reporting

      A.   Cantley Opinion

      In January 2002 Cantley mailed Mr. Fishman a 100-page

opinion letter regarding the MLD transactions.   The opinion

concluded, inter alia, that it was more likely than not that:

(1) The obligations under the short option would not be treated

as liabilities for purposes of section 752; (2) when Mr. Fishman

contributed his interest in LKF to LKF CC, his basis in LKF CC

was equal to the premium due from LKF for the long option feature

of the MLD transaction plus any cash held by LKF; and (3) LKF

CC’s purchase of CF Advisors’ interest resulted in a deemed

liquidation of LKF for Federal tax purposes under section

708(b)(1)(A), and LKF CC took LKF’s remaining assets (other than

cash and marketable securities) with an adjusted basis equal to



      16
      The parties stipulated that LKF sold the Canadian currency
position.
                                - 12 -

LKF CC’s adjusted basis in LKF immediately before the deemed

distribution (reduced by any cash and marketable securities

deemed received), see sec. 732(b).

     B.   LKF’s Form 1065

     LKF timely filed its Form 1065.     On Schedules K-1, Partner’s

Share of Income, Credits, Deductions, etc., LKF reported capital

contributions by LKF CC of $2,130,000, consisting of $130,000

cash and $2 million of MLD transactions, and contributions by CF

Advisors of $2,000.     LKF CC’s contribution of $2 million

represented a   2,197,802 premium, converted to U.S. dollars at

the spot rate of 0.91, that LKF was required to pay Deutsche Bank

under the terms of the long option.      LKF CC and LKF did not treat

the obligations under the short option as liabilities under

section 752(b) and did not reduce LKF CC’s basis in the

partnership interest by the short option premium.

     On the Form 1065 LKF reported the following separately

stated partnership items:

                 Item                          Amount
      Interest income                        $1,316,000
      Interest expense                       (1,302,800)
      Dividend income                               405
      Net loss on digital options                (1,687)
      Guaranteed payments to
        CF Advisors                              (8,000)
      Wire fees                                     (30)
      Nondeductible expenses                        (15)
        Total                                     3,873

All separately stated partnership items were allocated to LKF CC.
                                - 13 -

     LKF also reported distributions to its partners of $132,873

cash and the Canadian currency position to LKF CC and $2,000 to

CF Advisors.17    Under section 732(b) LKF CC allocated its

remaining basis in LKF partnership interest to the Canadian

currency position as the only partnership asset other than cash.

Accordingly, LKF assigned the Canadian currency position an

adjusted basis of $2,001,000.

     C.    Mr. Fishman’s 2001 Return

     On his 2001 Form 1040 Mr. Fishman included LKF CC as an S

corporation.     Mr. Fishman reported a nonpassive loss from LKF’s

Schedule K-1 of $2,001,809.    The loss represented LKF CC’s loss

on the sale of the Canadian currency position that LKF CC

received in a deemed distribution in the LKF liquidation; the

Canadian currency position was sold for $878.07, with the

substituted basis of $2,001,000.    Mr. Fishman combined this

nonpassive loss from LKF with other income of $2,042,730,

primarily related to Mr. Fishman’s business, Trident Labs, Inc.,

and reported total partnership and S corporation income of

$23,606.




     17
      The parties incorrectly stipulated the amount of
distribution to CF Advisors, but the exact amount is irrelevant
for purposes of deciding the parties’ motions.
                             - 14 -

III. FPAA and the Parties’ Stipulations of Settled Issues

     Respondent examined LKF’s 2001 Form 1065 and on December 28,

2005, mailed an FPAA to LKF CC as tax matters partner.18    In the

FPAA respondent adjusted partnership items as follows:

              Item                    As Reported   As Corrected
Portfolio income interest             $1,316,000         -0-
Portfolio income dividends                   405         -0-
Other portfolio income (loss)             (1,687)        -0-
Guaranteed payments to partner             8,000        $8,000
Deductions related to portfolio
  income                                   8,030         -0-
Interest expense                       1,302,800         -0-
Investment income                      1,314,718         -0-
Investment expenses                        8,030         -0-
Net earnings from self-employment          8,000         8,000
Nondeductible expenses                        15         -0-
Distributions--money                     134,873       134,873
Distributions--property other
  than money                            2,001,000        -0-

In Exhibit A, Explanation of Items (explanation of items),

attached to the FPAA,19 respondent provided the following

explanations for the adjustments to LKF’s Form 1065:    (1) LKF was

not a partnership as a matter of fact; (2) even if LKF was a

partnership in fact, it was formed solely for tax avoidance

purposes, and various transactions had no business purpose,

lacked economic substance, constituted an economic sham, and were

abusive under section 1.701-2, Income Tax Regs.; and (3) LKF


     18
      Although on its Form 1065 LKF checked off that it is not
subject to secs. 6221-6233, it also designated a tax matters
partner.
     19
      The explanation of items is attached hereto as an
appendix.
                               - 15 -

should be disregarded, and all transactions should be treated as

entered into by LKF’s purported partners.   Respondent also

explained that the obligations under the short option provision

of the MLD transactions constituted liabilities under section

752, the assumption of which by LKF should reduce the partners’

outside bases.

     Although the FPAA did not adjust the partners’ outside bases

to zero, in the explanation of items respondent determined that

the partners failed to establish that the partners’ bases in the

long option were greater than zero and, accordingly, the partners

failed to establish that the adjusted bases in their respective

partnership interests were greater than zero.   In paragraph 9 of

the explanation of items respondent determined that penalties

under section 6662 applied.

     LKF CC, as LKF’s tax matters partner, timely filed a

petition contesting respondent’s determinations.   On June 25,

2008, the parties filed a stipulation of settled issues

(stipulation).   The parties stipulated that all of the disputed

partnership items should be adjusted in accordance with the FPAA,

(except the partnership item “Distributions--property other than

money”).20   Petitioner also stipulated:




     20
      For “Distributions--property other than money” the parties
stipulated $8,000, instead of $2,001,000 as LKF reported on the
Form 1065, or zero, as respondent determined in the FPAA.
                              - 16 -

          2. If the Court determines that it has
     jurisdiction in this case, petitioner stipulates that
     he does not intend to call any witnesses or offer any
     evidence in this proceeding, or otherwise contest the
     determinations made in the FPAA other than the
     determination that the valuation misstatement penalty
     imposed by I.R.C. § 6662(a), (b)(3), (e), and (h)
     applies to any underpayment resulting from the
     adjustments to partnership items.

     In the recitals part of the stipulation petitioner contends

that the Court lacks jurisdiction over certain issues addressed

in the FPAA and that any underpayment attributable to the

adjustments in the FPAA would not be subject to the valuation

misstatement prong of the accuracy-related penalty under section

6662(a), (b)(3), (e), and (h).   The recitals part of the

stipulation also states the following:

          Whereas, if the Court determines that it has
     jurisdiction in this case, petitioner does not intend
     to contest any of the issues raised in the FPAA other
     than the issue of whether the valuation misstatement
     penalty would apply in this case, and whether
     respondent has the burden of production for any I.R.C.
     § 6662 penalty under I.R.C. § 7491(c);

          Whereas, aside from the Stipulation of Facts to be
     prepared and submitted, the petitioner does not intend
     to offer any witnesses or further evidence on the
     valuation misstatement penalty issue * * *

     Respondent asserts that summary judgment is appropriate

because petitioner stipulated the adjustments in the FPAA and

does not contest the determinations made in the FPAA, other than

the determination that the valuation misstatement prong of the

accuracy-related penalty under section 6662(a), (b)(3), (e), and

(h) applies.   Respondent argues that the gross valuation
                                - 17 -

misstatement prong of the penalty applies because the

determinations in the FPAA, which petitioner conceded, caused the

partners’ bases in LKF to be reduced to zero which, in turn,

resulted in a reduction in the basis of the Canadian currency

position LKF CC received in LKF’s deemed liquidation.

     Petitioner filed a motion for summary judgment asserting

that it had stipulated the numerical adjustments in the FPAA and

that the Court lacks jurisdiction over nonnumerical

determinations in the explanation of items because such

determinations purport to eliminate LKF’s partners’ outside bases

in LKF.   Petitioner argues the Court lacks jurisdiction over

outside basis adjustments.   Petitioner also argues that

respondent’s determinations of sham, economic substance, and tax

avoidance are not partnership items and cannot be litigated in a

partnership-level proceeding.

     This case is ripe for summary judgment because the parties

do not dispute the facts and we may render a decision as a matter

of law.

                             Discussion

I.   Summary Judgment

     Summary judgment is designed to expedite litigation and

avoid unnecessary, time-consuming, and expensive trials.      Fla.

Peach Corp. v. Commissioner, 

, 681 (1988).      Summary

judgment may be granted with respect to all or any part of the
                               - 18 -

legal issues presented “if the pleadings, answers to

interrogatories, depositions, admissions, and any other

acceptable materials, together with the affidavits, if any, show

that there is no genuine issue as to any material fact and that a

decision may be rendered as a matter of law.”   Rule 121(b);

Sundstrand Corp. v. Commissioner, 

, 520 (1992), affd.

(7th Cir. 1994).   The moving party bears the burden

of proving that there is no genuine issue of material fact, and

factual inferences will be drawn in a manner most favorable to

the party opposing summary judgment.    Dahlstrom v. Commissioner,

, 821 (1985); Jacklin v. Commissioner, 

,

344 (1982).   The nonmoving party, however, cannot rest upon the

allegations or denials in his pleadings but must “set forth

specific facts showing that there is a genuine issue for trial.”

Rule 121(d); Dahlstrom v. 

at 820-821.

II.   Respondent’s Determinations Regarding Nonpenalty Issues

      A.   General TEFRA Procedures

      For Federal income tax purposes partnerships are not taxable

entities, but they are required to file annual information

returns reporting items of gross income and deductions and other

information as the Secretary may prescribe.   Secs. 701, 6031.

Each partner then is required to report all partnership items on

his Federal income tax return consistently with the Schedule K-1

received from the partnership.   Secs. 701, 702, 703, and 704.
                              - 19 -

Congress enacted the unified audit and litigation procedures of

the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA),

Pub. L. 97-248, sec. 402(a), 96 Stat. 648, to provide consistent

treatment of partnership items among partners of the same

partnership and to lessen the administrative and judicial burdens

that arose from duplicative audits and litigation.    See Randell

v. United States, 

, 103 (2d Cir. 1995); H. Conf. Rept.

97-760, at 599-600 (1982), 1982-2 C.B. 600, 662-663.

     A partnership item is any item the Secretary has determined

is more appropriately determined at the partnership level than at

the partner level.   Sec. 6231(a)(3); sec. 301.6231(a)(3)-1(a),

Proced. & Admin. Regs.   The term “partnership item” includes not

only items of income, gain, loss, deduction, or credit of the

partnership, see sec. 301.6231(a)(3)-1(a)(1), Proced. & Admin.

Regs., but also legal and factual determinations that underlie

the determination of the amount, timing, and characterization of

items of income, credit, gain, loss, deduction, etc., see sec.

301.6231(a)(3)-1(b), Proced. & Admin. Regs.    A nonpartnership

item is an item that is not a partnership item; its tax treatment

is determined at the partner level.    Sec. 6231(a)(4).   The proper

tax treatment of any partnership item must be determined in a

single partnership-level proceeding, sec. 6221, and the result of

such proceeding then applies to each individual partner’s tax

return, Roberts v. Commissioner, 

, 859-860 (1990).
                                - 20 -

     After a final partnership-level adjustment has been made to

a partnership item in a unified partnership proceeding, the

Commissioner may assess a corresponding computational adjustment

to a partner’s tax liability without issuing a notice of

deficiency.    Secs. 6225(a), 6230(a)(1); N.C.F. Energy Partners v.

Commissioner, 

, 744 (1987); sec. 301.6231(a)(6)-1(a),

Proced. & Admin. Regs.; sec. 301.6231(a)(6)-1T(a), Temporary

Proced. & Admin. Regs., 64 Fed. Reg. 3840 (Jan. 26, 1999).

However, if an increased liability stemming from an affected item

requires a factual determination at the partner level, normal

deficiency procedures under sections 6212 and 6213 apply to such

adjustment to a partner’s tax liability (other than penalties,

additions to tax, and additional amounts that relate to

adjustments to partnership items).       See sec. 6230(a)(2)(A)(i);

Domulewicz v. Commissioner, 

, 19 (2007).       The

Commissioner must issue an affected items notice of deficiency to

the partner in order to assess tax attributable to the affected

item.     See sec. 6230(a)(2)(A)(i); sec. 301.6231(a)(6)-1(a)(3),

Proced. & Admin. Regs.; sec. 301.6231(a)(6)-1T(a)(2), Temporary

Proced. & Admin. 

.

     B.      Whether LKF Should Be Disregarded for Tax Purposes

     Petitioner contends the term “partnership item” includes

only accounting items and does not refer to judicial doctrines of

sham or lack of economic substance.       Petitioner argues that we
                               - 21 -

lack jurisdiction in this partnership-level proceeding to

consider such issues as well as the question of outside basis,

which is an affected item.21

     This Court is a court of limited jurisdiction, and we may

exercise our jurisdiction only to the extent provided by

Congress.   See sec. 7442; GAF Corp. & Subs. v. Commissioner, 

, 521 (2000).   In a partnership-level proceeding our

jurisdiction is limited to determining partnership items of the

partnership for the taxable year to which the FPAA relates, the

proper allocation of such items among the partners, and the

applicability of any penalty, addition to tax, or additional

amount with respect to an adjustment to a partnership item.     Sec.

6226(f).

     The determinations in the explanation of items in this case

are similar to those contained in exhibit A to the FPAA in




     21
      Petitioner also points out that in the stipulation of
settled issues respondent allowed three partnership items
(guaranteed payments, net earnings from self-employment, and
distributions of money). Although petitioner argues that those
allowances are inconsistent with allegations of sham and
disregarding partnership, we do not believe that the settlement
of adjustments between parties operates to prevent the parties or
this Court from addressing and resolving other issues that have
not been settled and are properly before the Court.
                              - 22 -

Petaluma FX Partners, LLC v. Commissioner, 131 T.C. ___ (2008),22

in which we addressed arguments similar to petitioner’s.   In

Petaluma we held that a determination whether a partnership is a

sham, lacks economic substance, or otherwise should be

disregarded for tax purposes is a partnership item and that we

have jurisdiction over such determinations.

___ (slip op.

at 22); see also RJT Invs. X v. Commissioner, 

, 737

(8th Cir. 2007).   Although we recognized that in some situations

a partner’s outside basis in a partnership interest may be an

affected item more appropriately determined at the partner level,

see Domulewicz v. 

at 20; Ginsburg v.

Commissioner, 

, 82-83 (2006); Dial USA, Inc. v.

Commissioner, 

, 5-6 (1990), we held that when a

partnership is disregarded for Federal income tax purposes, the

Court has jurisdiction in a partnership-level proceeding to

determine that there can be no outside bases in the partnership.

Petaluma FX Partners, LLC v. 

at ___ (slip op.

at 26).   We see no reason to revisit our holding in Petaluma, and

we conclude that we have jurisdiction over the determinations at

issue.




     22
      Petaluma FX Partners, LLC v. Commissioner, 131 T.C. ___
(2008), is currently on appeal to the Court of Appeals for the
D.C. Circuit, which is the venue for appeal in this case also, as
discussed infra. Petitioner’s counsel is counsel for the
taxpayer in Petaluma, and the parties’ briefs are very similar.
                                 - 23 -

       Like the partner in Petaluma, petitioner stipulated that it

would not contest the determination that the relevant entity

(here LKF) should be disregarded, other than on jurisdictional

grounds.      When a party states that it does not intend to contest

an issue, we have found it appropriate to deem the issue

conceded.      See

___ (slip op. at 9); see also DeCaprio v.

Commissioner, T.C. Memo. 1996-367.        Accordingly, we hold that LKF

should be disregarded for tax purposes, and the partners have no

outside bases in a disregarded partnership.       See Petaluma FX

Partners, LLC v. 

at ___ (slip op. at 26).

III. Penalties

       A.    The Parties’ Stipulation on Penalties

       Respondent stated in paragraph 9 of the explanation of items

that the adjustments in the FPAA were attributable to a tax

shelter, for which LKF had no substantial authority or reasonable

cause.      Respondent determined that the entire underpayment of tax

resulting from those adjustments is attributable to (1) gross or

substantial valuation misstatement under section 6662(a), (b)(3),

(e), and (h); (2) negligence or disregard of rules or regulations

under section 6662(a), (b)(1), and (c); or (3) substantial

understatements of income tax under section 6662(a), (b)(2), and

(d).

       Petitioner stipulated that it is contesting only the

applicability of the valuation misstatement prong of the
                                - 24 -

accuracy-related penalty (valuation misstatement penalty).       We

treat this stipulation as conclusive and binding on petitioner

and deem issues with respect to the negligence and substantial

understatement prongs of the section 6662 accuracy-related

penalty conceded.     See Rule 91(e); Petaluma FX Partners, LLC v.

at ___ (slip. op. at 31); Stamos v.

Commissioner, 

, 1454-1455 (1986).     Accordingly, we

consider only the applicability of the valuation misstatement

penalty.23

     B.      Jurisdiction Over Valuation Misstatement Penalty
             Determination

     Section 6662(a) imposes a 20-percent accuracy-related

penalty on the portion of an underpayment of tax attributable to

items set forth in section 6662(b).      Section 6662(b)(3) specifies

as one such item a substantial valuation misstatement.     A

substantial valuation misstatement occurs if the value or the

adjusted basis of any property claimed on any return is 200

percent or more of the correct amount.     Sec. 6662(e)(1)(A).    The

penalty is increased to 40 percent if the underpayment of tax

results from a gross valuation misstatement, which occurs if the




     23
      The Commissioner may not stack or compound parts of the
accuracy-related penalty to impose a penalty in excess of 20
percent on any given portion of an underpayment, or 40 percent,
if such portion is attributable to a gross valuation
misstatement. Sec. 1.6662-2(c), Income Tax Regs.
                               - 25 -

value or adjusted basis of any property claimed on a return is

400 percent or more of the correct amount.    Sec. 6662(h)(2)(A).

     Section 6221 provides that the applicability of any penalty,

addition to tax, or additional amount which relates to an

adjustment to a partnership item is determined at the partnership

level.    See also sec. 6226(f); sec. 301.6221-1(c), Proced. &

Admin. Regs.; sec. 301.6221-1T(c), Temporary Proced. & Admin.

Regs., 64 Fed. Reg. 3838 (Jan. 26, 1999).    If a penalty was

imposed at the partnership level during the TEFRA proceeding, the

Commissioner may assess that amount without issuing a notice of

deficiency.    Sec. 6230(a)(1); sec. 301.6231(a)(6)-1(a), Proced. &

Admin. Regs.; sec. 301.6231(a)(6)-1T(a), Temporary Proced. &

Admin. 

.    The determination under the FPAA or under

the decision of a court regarding the applicability of any

penalty relating to an adjustment to a partnership item is deemed

conclusive, sec. 6230(c)(4), but a partner may file a claim for

refund and assert any partner-level defenses that may apply or

challenge the amount of the computational adjustment, sec.

301.6221-1(c) and (d), Proced. & Admin. Regs.; sec. 301.6221-

1T(c) and (d), Temporary Proced. & Admin. Regs., 64 Fed. Reg.

3838 (Jan. 26, 1999); see also New Millennium Trading, L.L.C. v.

Commissioner, 131 T.C. ___ (2008) (upholding the validity of

section 301.6221-1T(c) and (d), Temporary Proced. & Admin. 

).    Accordingly, in a partnership-level proceeding we may
                              - 26 -

not consider partner-level defenses to any penalty, addition to

tax, or additional amount that relate to an adjustment to a

partnership item.   Sec. 301.6221-1(c) and (d), Proced. & Admin.

Regs.; sec. 301.6221-1T(c) and (d), Temporary Proced. & Admin.

; see also New Millennium Trading, L.L.C. v.

at ___ (slip op. at 19-23).

     Petitioner argues that the Court does not have jurisdiction

to determine a penalty with respect to an adjustment to an

affected item, such as outside basis.   We held in Petaluma FX

Partners, LLC v. Commissioner, 131 T.C. at ___ (slip op. at 29),

that if a partnership is disregarded for tax purposes and the

partners’ collective basis in the partnership is zero, the Court

has jurisdiction to determine the applicability of accuracy-

related penalties that result from the determination.     As in

Petaluma, we hold that LKF should be disregarded for Federal tax

purposes and the partners cannot have outside bases in a

disregarded entity.   Accordingly, we may determine the

applicability of the valuation misstatement penalty.

     C.   Burden of Production

     Section 7491(c) places the initial burden of production in

any court proceeding on the Commissioner “with respect to the

liability of any individual” for any penalty, addition to tax, or

additional amounts imposed by the Code.   The burden of proof,

however, remains on the taxpayer.   Higbee v. Commissioner, 116
                               - 27 -

T.C. 438, 446-447 (2001).    Petitioner argues that section 7491(c)

applies because respondent asserts penalties against partners and

that respondent failed to carry his burden of production under

section 7491(c).   Respondent contends that he does not have the

burden of production because the penalty determination is made at

the partnership level and section 7491(c) applies only when the

taxpayer is an individual.   Respondent asserts that even if

section 7491(c) applies, he has met his burden of production.     We

do not need to resolve the disagreement because even if the

burden of production under section 7491 lies with respondent, he

satisfied the threshold requirement supporting his determination

that the gross valuation misstatement penalty is appropriate.

     D.   The Valuation Misstatement Penalty

     Respondent argues that the partners’ collective basis in LKF

should be zero instead of the amount claimed.   Respondent also

contends the valuation misstatement penalty applies because the

inflated basis in the Canadian currency position originates in

the partnership’s misstatement of Mr. Fishman’s contribution

amount and his resulting basis in the partnership interest.

     Petitioner argues the valuation misstatement penalty is

inappropriate because the record does not support a factual

determination of sham or lack of economic substance.   Petitioner

believes that by carving out the right to contest the valuation
                              - 28 -

misstatement penalty it preserved the right to argue that the

transactions had a business purpose.   We disagree.

     The parties’ stipulation clearly states that if the Court

finds it has jurisdiction, petitioner does not intend to contest

the determinations made in the FPAA other than the valuation

misstatement penalty.   Stipulations are conclusive and binding on

the parties unless otherwise permitted by the Court.   Rule 91(e);

Stamos v. Commissioner, 

.   In Petaluma FX

Partners, LLC v. 

at ___ (slip op. at 39), the

parties’ stipulations were substantially similar to the

stipulation in this case.   We construed the language to preclude

the taxpayer’s challenge of the penalty on the merits and did not

allow the taxpayer to qualify or change the stipulation.   See

also DeCaprio v. Commissioner, T.C. Memo. 1996-367.    We take a

similar approach here and conclude that petitioner waived its

right to argue that the underlying transactions had economic

substance as a defense to the valuation misstatement penalty.

     Petitioner argues the valuation misstatement penalty is

inapplicable as a matter of law because the underpayment of tax

is not attributable to erroneous valuation but rather to

disregard of a partnership.   In support petitioner relies on,

among other cases, Klamath Strategic Inv. Fund, LLC v. United

States, 

(E.D. Tex. 2007), affd. in part,

vacated in part and remanded on a different issue 

                              - 29 -

(5th Cir. 2009),24 a partnership-level case in which the U.S.

District Court for the Eastern District of Texas held that a

certain tax shelter lacked economic substance.   In Klamath, the

Government argued that the gross valuation penalty applied

because the taxpayers’ basis in euro distributed by a partnership

exceeded the true basis and the 400-percent threshold was met.

899.   The taxpayers argued the gross valuation penalty

does not apply when the Commissioner totally disallows a

deduction or credit, and the case was similar to disallowance of

a deduction or credit.

899-900.   The court agreed with

the taxpayer and stated that under the law in the Fifth Circuit,

if the court disregarded transactions for lack of economic

substance the underpayment of tax was not attributable to gross

valuation but rather to the disregard of the transaction.

Commissioner, 

, 383 (5th Cir.

1990), revg. T.C. Memo. 1988-408)).

     Relying on Weiner v. United States, 

(5th Cir.

2004), petitioner also contends that because respondent advanced



     24
      Petitioner cites Klamath Strategic Inv. Fund, LLC v.
United States, 

(E.D. Tex. 2006) (addressing,
on the parties’ motions for summary judgment, whether certain
loans were contingent obligations under sec. 752 and whether sec.
1.752-6, Income Tax Regs., was valid). We assume that petitioner
intended to rely on Klamath Strategic Inv. Fund, LLC v. United
States, 

(E.D. Tex. 2007) (considering the
transactions on merits and refusing to apply the gross valuation
penalty), affd. in part, vacated in part and remanded 

(5th Cir. 2009).
                               - 30 -

several alternative theories for adjusting partnership items, it

is impossible to determine whether the partners’ underpayments

are attributable to a valuation overstatement.   Petitioner also

suggests that under Gainer v. Commissioner, 

(9th

Cir. 1990), affg. T.C. Memo. 1988-416, and Todd v. Commissioner,

(5th Cir. 1988), affg. 

(1987), the

valuation misstatement penalty does not apply when the deduction

or credit is disallowed in total for reasons other than the fact

that the basis of the property was inflated.   See also Keller v.

Commissioner, 

, 1061 (9th Cir. 2009) (stating that

the Court of Appeals for the Ninth Circuit adheres to Gainer v.

, and does not uphold a penalty for

overvaluing an asset when a deduction is disallowed in total),

affg. in part and revg. in part T.C. Memo. 2006-131.   We disagree

that Gainer controls our decision because in Gainer we disallowed

a tax credit where the asset had not been placed in service and

the case is distinguishable.   See Gainer v. Commissioner, T.C.

Memo. 1988-416.

     In Golsen v. Commissioner, 

, 757 (1970), affd.

(10th Cir. 1971), we held that we follow a decision

of the Court of Appeals to which an appeal from our disposition

of a case lies when that decision is squarely on point and a

failure to follow that decision would result in an inevitable

reversal, because of the clearly established position of the
                                - 31 -

Court of Appeals.    See also Lardas v. Commissioner, 

,

494-495 (1992).     Section 7482(b)(1)(E) provides that in the case

of a petition under section 6226, a decision by this Court may be

reviewed by the U.S. Court of Appeals for the circuit in which

the partnership has its principal place of business.     Appellate

venue under section 7482 is determined as of the time the

petition is filed with the Court.    Sec. 7482(b)(1).   If no

subparagraph of section 7482(b)(1) applies, the decision may be

reviewed by the Court of Appeals for the District of Columbia

Circuit.

when the petition was filed, LKF had

no principal place of business.    Petitioner states in its

petition that LKF’s legal residence was California when it filed

the petition.    However, petitioner then stipulated that LKF filed

its 2001 Form 1065 as a final return, in December 2001 LKF

distributed its assets to the partners, and the partnership was

deemed liquidated for Federal income tax purposes.      Accordingly,

we conclude that LKF did not have a principal place of business

when the petition was filed, and this case may be appealable to

the Court of Appeals for the District of Columbia Circuit.      See

Petaluma FX Partners, LLC v. Commissioner, 131 T.C. at ___ (slip

op. at 33).   The Court of Appeals for the District of Columbia

Circuit has yet to consider the issue of whether the valuation

misstatement penalty applies to underpayments attributable to
                                 - 32 -

overstated basis in property where the transaction is found to be

a sham or lacking economic substance.      Accordingly, we may give

effect to our own views.      See Golsen v. 

at

757.

       In Petaluma we held that if a partnership is disregarded for

tax purposes, the gross valuation misstatement penalty applies.

Petaluma FX Partners, LLC v. 

at ___ (slip op.

at 34).      In so holding, this Court has followed the approach

adopted by the Courts of Appeals for the Second, Third, Fourth,

Sixth, and Eighth Circuits.      Merino v. Commissioner, 

, 158-159 (3d Cir. 1999), affg. T.C. Memo. 1997-385; Zfass v.

Commissioner, 

, 190-191 (4th Cir. 1997), affg. T.C.

Memo. 1996-167; Illes v. Commissioner, 

, 167 (6th

Cir. 1992), affg. T.C. Memo. 1991-449; Gilman v. Commissioner,

, 151 (2d Cir. 1991), affg. T.C. Memo. 1989-684,

supplemented by T.C. Memo. 1990-205; Massengill v. Commissioner,

, 619-620 (8th Cir. 1989), affg. T.C. Memo. 1988-427.

We agree with these Courts of Appeals and see no reason to

revisit our holding in Petaluma FX Partners, LLC v. 

.      Accordingly, we conclude that the gross valuation

misstatement penalty applies.

       E.     Partnership-Level Defenses

       When considering penalties at the partnership level, we may

consider defenses of the partnership, such as the reasonable
                               - 33 -

cause exception.    See sec. 6664(c); New Millennium Trading,

L.L.C. v. Commissioner, 131 T.C. at ___ (slip op. at 9);

Whitehouse Hotel Ltd. Pship. v. Commissioner, 131 T.C. ___, ___

(2008) (slip op. at 90); Santa Monica Pictures, LLC v.

Commissioner, T.C. Memo. 2005-104.      Reasonable cause requires

that the taxpayer have exercised ordinary business care and

prudence as to the disputed item.    See Neonatology Associates,

P.A. v. Commissioner, 

, 98 (2000), affd. 

(3d Cir. 2002).    The determination of whether a taxpayer acted

with reasonable cause and in good faith is made on a case-by-case

basis, taking into account all pertinent facts and circumstances.

Sec. 1.6664-4(b)(1), Income Tax Regs.     The “most important factor

is the extent of the taxpayer’s effort to assess the taxpayer’s

proper tax liability”, taking into account the experience,

knowledge, and education of the taxpayer.

petitioner claimed that “assuming some or

all of the Commissioner’s adjustments are correct, there was

reasonable cause for Petitioner’s positions and the Petitioner

acted in good faith.”    In the stipulation of settled issues

petitioner stipulated that it did not intend to offer any

witnesses or further evidence on the valuation misstatement

issue.25   In its opposition to respondent’s motion for summary


     25
      Although the parties stipulated the Cantley opinion as a
joint exhibit, petitioner is not arguing in its briefs that LKF
                                                   (continued...)
                              - 34 -

judgment petitioner does not argue that LKF had any partnership-

level defenses to the valuation misstatement penalty, does not

state which facts would support a finding that reasonable cause

existed, and does not claim there is a genuine issue as to a

material fact with respect to any partnership-level defenses.

Accordingly, we conclude there is no genuine issue as to any

material fact regarding potential partnership-level defenses.

See Rule 121(b); Jarvis v. Commissioner, 

, 658-659

(1982).

IV.   Conclusion

      On the basis of the foregoing, we shall deny petitioner’s

motion for summary judgment and grant respondent’s motion for

summary judgment.

      We have considered the parties’ remaining arguments, and to

the extent not discussed above, we conclude those arguments are

irrelevant, moot, or without merit.

      To reflect the foregoing,


                                       An appropriate order and

                                  //decision will be entered.




      25
      (...continued)
relied on an opinion of a professional tax adviser.
                        - 35 -

                        APPENDIX
           Exhibit A - Explanation of Items

1.   It is determined that neither LKF X Investments, L.L.C.
     nor its purported partners have established the
     existence of LKF X Investments, L.L.C. as a partnership
     as a matter of fact.

2.   Even if LKF X Investments, L.L.C. existed as a
     partnership, the purported partnership was formed and
     availed of solely for purposes of tax avoidance by
     artificially overstating basis in the partnership
     interests of its purported partners. The formation of
     LKF X Investments, L.L.C., the acquisition of any
     interest in the purported partnership by the purported
     partner, the purchase of offsetting positions on
     market-linked deposits, the transfer of offsetting
     positions held by LKF X Investments, L.L.C. to LKF
     Capital X Corp., the purchase of assets by the
     partnership, and the distribution of those assets to
     the purported partners in complete liquidation of the
     partnership interests, and the subsequent sale of those
     assets to generate a loss, all within a period of less
     than 4 months, had no business purpose other than tax
     avoidance, lacked economic substance, and, in fact and
     substance, constitutes an economic sham for Federal
     income tax purposes. Accordingly, the partnership and
     the transactions described above shall be disregarded
     in full and any purported losses resulting from these
     transactions are not allowable as deductions for
     Federal income tax purposes.

3.   It is determined that LKF X Investments, L.L.C. was a
     sham, lacked economic substance and, under § 1.701-2 of
     the Income Tax Regulations, was formed and availed of
     in connection with a transaction or transactions in
     taxable year 2001, a principal purpose of which was to
     reduce substantially the present value of its partners’
     aggregate Federal tax liability in a manner that is
     inconsistent with the intent of Subchapter K of the
     Internal Revenue Code. It is consequently determined
     that:

     a.   LKF X Investments, L.L.C. is disregarded and all
          transactions engaged in by LKF X Investments,
          L.L.C. are treated as engaged in directly by its
          purported partners. This includes the
          determination that the assets purportedly acquired
                        - 36 -

          by LKF X Investments, L.L.C., including but not
          limited to foreign currency options, were acquired
          directly by the purported partners.

     b.   The positions in market-linked deports [sic]
          purportedly acquired by or assumed by LKF X
          Investments, L.L.C. are treated as never having
          been acquired by or assumed by said partnership
          and any gains or losses purportedly realized by
          LKF X Investments, L.L.C. on the positions in
          market-linked deposits are treated as having been
          realized by its partners.

     c.   The purported partners of LKF X Investments,
          L.L.C. should be treated as not being partners in
          LKF X Investments, L.L.C.

     d.   Acquisitions by LKF X Investments, L.L.C. will be
          adjusted to reflect clearly the partnership’s or
          purported partners’ income.

4.   It is determined that the obligations under the short
     positions on market-linked deposits sold are
     liabilities within the meaning of § 752 of the Internal
     Revenue Code, the assumption of which by LKF X
     Investments, L.L.C. shall reduce the purported
     partners’ bases in LKF X Investments, L.L.C. in the
     amount of $2,000,000 for LKF X Capital Corp., but not
     below the fair market value of the purported
     partnership interest.

5.   It is determined that neither LKF X Investments, L.L.C.
     nor its purported partners entered into the positions
     on market-linked deposits or purchased the foreign
     currency or stock with a profit motive for purposes of
     § 165(c)(2) of the Internal Revenue Code.

6.   It is determined that, even if the positions on market-
     linked deposits are treated as having been contributed
     to LKF Investments, L.L.C., the amount treated as
     contributed by the partners under § 722 of the Internal
     Revenue Code is reduced by the amounts received by the
     contributing partner(s) from the contemporaneous sales
     of the offsetting position to the same counter-party.
     Thus, the basis of the contributed position is reduced,
     both in the hands of the contributing partners and LKF
     X Investments, L.L.C. Consequently, any corresponding
     claimed increases in the outside basis in LKF X
                        - 37 -

     Investments, L.L.C. resulting from the acquisitions or
     contributions of the positions on market-linked
     deposits are disallowed. Also, any corresponding
     claimed increases in basis in LKF X Capital Corp.
     resulting from the contribution by Taxpayer of his
     interest in LKF X Investments to LKF X Capital Corp.
     are disallowed.

7.   It is determined that the adjusted bases of the long
     position(s) on market-linked deposits and other
     contributions purportedly acquired by the LKF X
     Investments, L.L.C. and contributed to LKF X Capital
     Corp. has not been established under § 723 of the
     Internal Revenue Code. It is consequently determined
     that the partners of LKF X Investments, L.L.C. have not
     established adjusted bases in their respective
     partnership interests in an amount greater than zero.

8.   It is further determined that, in the case of a sale,
     exchange, or liquidation of LKF X Investments, L.L.C.
     partners’ partnership interests, neither the purported
     partnership nor its purported partners have established
     that the bases of the partners’ partnership interests
     were greater than zero for purposes of determining gain
     or loss to such partners from the sale, exchange, or
     liquidation of such partnership interest.

9.   Accuracy-Related Penalties:

     It is determined that the adjustments of partnership
     items of LKF X Investments, L.L.C. are attributable to
     a tax shelter for which no substantial authority has
     been established for the position taken, and for which
     there was no showing of reasonable belief by the
     partnership or its partners that the position taken was
     more likely than not the correct treatment of the tax
     shelter and related transactions. In addition, all of
     the underpayments of tax resulting from those
     adjustments of partnership items are attributable to,
     at a minimum, (1) substantial understatements of income
     tax, (2) gross valuation misstatement(s), or (3)
     negligence or disregarded rules or regulations. There
     has not been a showing by the partnership or any of its
     partners that there was reasonable cause for any of the
     resulting underpayments, that the partnership or any of
     its partners acted in good faith, or that any other
     exceptions to the penalty apply. It is therefore
     determined that, at a minimum, the Accuracy-Related
                   - 38 -

Penalty under § 6662(a) of the Internal Revenue Code
applies to all underpayments of tax attributable to
adjustments of partnership items of LKF X Investments
L.L.C. The penalty shall be imposed on the components
of underpayment as follows:

A.   A 40 percent penalty shall be imposed on the
     portion of any underpayment attributable to the
     gross valuation misstatement as provided by §§
     6662(a), 6662(b)(3), 6662(e), and 6662(h) of the
     Internal Revenue Code.

B.   A 20 percent penalty shall be imposed on the
     portion of the underpayment attributable to
     negligence or disregard of rules and regulations
     as provided by §§ 6662(a), 6662(b)(1), 6662(c) of
     the Internal Revenue Code.

C.   A 20 percent penalty shall be imposed on the
     underpayment attributable to the substantial
     understatement of income tax as provided by §§
     6662(a), 6662(b)(2), and 6662(d) of the Internal
     Revenue Code.

D.   A 20 percent penalty shall be imposed on the
     underpayment attributable to the substantial
     valuation misstatement as provided by §§ 6662(a),
     6662(b)(3), and 6662(e) of the Internal Revenue
     Code.

It should not be inferred by the determination of the
Accuracy-Related Penalty in this notice that fraud
penalties will not be sought on any portion of an
underpayment subsequently determined to be attributable
to fraud or that prosecution for criminal offenses will
not be sought under §§ 7201 or 7206 of the Internal
Revenue Code or other provisions of Federal law if
determined to be appropriate.