Filed: Dec. 15, 2010
Latest Update: Mar. 03, 2020
Summary: PETALUMA FX PARTNERS, LLC, RONALD SCOTT VANDERBEEK, A PARTNER OTHER THAN THE TAX MATTERS PARTNER, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT* Docket No. 24717–05. Filed December 15, 2010. On remand we are instructed by the Court of Appeals for the District of Columbia Circuit to determine whether we have jurisdiction to determine whether a penalty under sec. 6662, I.R.C., is applicable in this partnership-level case. Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649 (D.C. C
Summary: PETALUMA FX PARTNERS, LLC, RONALD SCOTT VANDERBEEK, A PARTNER OTHER THAN THE TAX MATTERS PARTNER, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT* Docket No. 24717–05. Filed December 15, 2010. On remand we are instructed by the Court of Appeals for the District of Columbia Circuit to determine whether we have jurisdiction to determine whether a penalty under sec. 6662, I.R.C., is applicable in this partnership-level case. Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649 (D.C. Ci..
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PETALUMA FX PARTNERS, LLC, RONALD SCOTT VANDERBEEK,
A PARTNER OTHER THAN THE TAX MATTERS PARTNER,
PETITIONER v. COMMISSIONER OF INTERNAL
REVENUE, RESPONDENT*
Docket No. 24717–05. Filed December 15, 2010.
On remand we are instructed by the Court of Appeals for
the District of Columbia Circuit to determine whether we
have jurisdiction to determine whether a penalty under sec.
6662, I.R.C., is applicable in this partnership-level case.
Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649
(D.C. Cir. 2010), affg. in part, revg. in part, and vacating in
part 131 T.C. 84 (2008). Held: Applying the instructions set
forth in the Court of Appeals’ opinion, we do not have jurisdic-
tion over any sec. 6662, I.R.C., penalty determination in this
case.
Edward M. Robbins, Jr., for petitioner.
Gerald A. Thorpe and Jason M. Kuratnick, for respondent.
SUPPLEMENTAL OPINION
GOEKE, Judge: This matter is before the Court on remand
from the Court of Appeals for the District of Columbia Cir-
cuit for further proceedings consistent with its opinion in
Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649
(D.C. Cir. 2010), affg. in part, revg. in part, and vacating in
part 131 T.C. 84 (2008). The issue for decision on remand is
whether this Court has jurisdiction over the determination in
respondent’s notice of final partnership administrative
adjustment (FPAA) issued to petitioner and other partners
that all of the underpayments of tax resulting from adjust-
ments of partnership items are attributable to: (1) Gross or
substantial valuation misstatements penalized under section
6662(a), (b)(3), (e), and (h); (2) negligence or disregard of
rules or regulations penalized under section 6662(a), (b)(1),
and (c); or (3) substantial understatements of income tax
penalized under section 6662(a), (b)(2), and (d). 1
* This Opinion supplements our prior Opinion, Petaluma FX Partners, LLC v. Commissioner,
131 T.C. 84 (2008), affd. in part, revd. in part, and vacated in part
591 F.3d 649 (D.C. Cir.
2010).
1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect
for the year in issue.
581
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582 135 UNITED STATES TAX COURT REPORTS (581)
Background
We summarize relevant background from Petaluma FX
Partners, LLC v. Commissioner, 131 T.C. 84 (2008)
(Petaluma I), and set forth additional details for purposes of
deciding the issue on remand.
The dispute in this case relates to an FPAA issued to peti-
tioner and other partners of Petaluma FX Partners, LLC
(Petaluma or the partnership), on July 28, 2005. In the FPAA
respondent made the following adjustments to items reported
on Petaluma’s partnership return for its 2000 tax year and
to outside bases of all the partners, items not reported on the
return:
Item As reported As corrected
Capital contributions $478,800 -0-
Distributions—property
other than money 171,806 -0-
Outside partnership bases 24,943,505 -0-
Distributions—money 206,076 -0-
Other income 107,242 -0-
Tax-exempt interest income 547 -0-
Assets—cash 171,939 -0-
Liabilities and capital—
other current liabilities 6,158 -0-
Partners’ capital accounts 165,781 -0-
None of the above items result in computational adjustments
(as defined in section 6231(a)(6)) to the partners’ tax liabil-
ities. Petitioner has previously stipulated that substantive
issues over which the Court has jurisdiction will not be con-
tested. Petitioner reserved the penalty for valuation
misstatement from his concession, but the Court of Appeals
has held that we do not have jurisdiction over that penalty.
Petaluma FX Partners, LLC v. Commissioner, 591 F.3d at
655. Form 4605–A, Examination Changes—Partnerships,
Fiduciaries, S Corporations, and Interest Charge Domestic
International Sales Corporations, attached to the FPAA
states: ‘‘I.R.C. Penalty Section 6662 is applicable at the indi-
vidual partner level and may be raised in separate pro-
ceedings at the partner level following the present partner-
ship proceeding.’’
This Court issued Petaluma I on October 23, 2008, holding
that it had jurisdiction to decide: (1) That Petaluma should
be disregarded for tax purposes; (2) that the partners had no
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bases in their interests in the partnership since the partner-
ship was disregarded; and (3) that a valuation misstatement
penalty under section 6662(b)(3) applied. Petaluma I, 131
T.C. 100. The Court of Appeals affirmed our determination
that we had jurisdiction to decide whether the partnership
should be disregarded. However, in this partnership-level
case it reversed our determination regarding partners’ out-
side bases, holding that we did not have jurisdiction. The
Court of Appeals remanded the case for a determination of
whether this Court has jurisdiction over any penalties under
section 6662. Petaluma FX Partners, LLC v. Commissioner,
591 F.3d at 656.
Discussion
Applying the mandate to reconsider whether we have juris-
diction over any section 6662 penalties, we conclude as
explained herein that this Court lacks jurisdiction over the
penalty issues in this partnership-level proceeding.
After the Court of Appeals issued the mandate, we ordered
the parties to state their respective positions regarding the
issues on remand, and both parties have complied. There
being no need for trial or further hearing, we review the par-
ties’ respective positions in the light of the opinion of the
Court of Appeals.
I. TEFRA in General
Under the Tax Equity and Fiscal Responsibility Act of
1982 (TEFRA), all partnership items are determined in a
single partnership-level proceeding. Sec. 6226; see also
Randell v. United States, 64 F.3d 101, 103 (2d Cir. 1995). In
a partnership-level proceeding, the Court’s jurisdiction is lim-
ited by section 6226(f):
SEC. 6226(f). SCOPE OF JUDICIAL REVIEW.—A court with which a peti-
tion is filed in accordance with this section shall have jurisdiction to deter-
mine all partnership items of the partnership for the partnership taxable
year to which the notice of final partnership administrative adjustment
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.
Section 6231(a) defines the terms ‘‘partnership item’’, ‘‘non-
partnership item’’, and ‘‘affected item’’:
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584 135 UNITED STATES TAX COURT REPORTS (581)
(3) PARTNERSHIP ITEM.—The term ‘‘partnership item’’ means, with
respect to a partnership, any item required to be taken into account for
the partnership’s taxable year under any provision of subtitle A to the
extent regulations prescribed by the Secretary provide that, for purposes
of this subtitle, such item is more appropriately determined at the partner-
ship level than at the partner level.
(4) NONPARTNERSHIP ITEM.—The term ‘‘nonpartnership item’’ means an
item which is (or is treated as) not a partnership item.
(5) AFFECTED ITEM.—The term ‘‘affected item’’ means any item to the
extent such item is affected by a partnership item.
An ‘‘affected item’’ is by definition not a ‘‘partnership item’’.
Ginsburg v. Commissioner, 127 T.C. 75, 79 (2006); see also
Dial USA, Inc. v. Commissioner, 95 T.C. 1, 5 (1990). This
distinction is important in the present case as affected items
generally will involve issuance of notices of deficiency to indi-
vidual partners, described as partner-level proceedings.
II. Petitioner’s Position
Petitioner first argues that this Court lacks jurisdiction to
determine the amounts of any penalties in this partnership-
level proceeding because no penalty relates to an adjustment
to a partnership item under section 6226(f). Petitioner main-
tains no underpayment arises as a result of any partnership
item because there is no computational deficiency adjustment
at the partner level as a result of our holding that Petaluma
is to be disregarded for tax purposes. Petitioner contends
that, in the light of the Court of Appeals’ holding that this
Court lacks jurisdiction to determine outside basis, there is
no deficiency or underpayment of tax within the jurisdiction
of this Court in respect of which a penalty can be held to
apply.
Petitioner also argues that because the partnership is a
nullity, no partnership item could create a deficiency or
underpayment to which penalties could apply. Therefore, any
penalty does not relate to an adjustment to a partnership
item, and any penalty is an item which must be determined
with a statutory notice of deficiency.
III. Respondent’s Position
Respondent argues that this Court has jurisdiction to
determine the applicability of the gross valuation
misstatement penalty because sections 6221, 6226(f), and
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6230(a) give this Court jurisdiction to determine penalties
related to partnership items. Respondent contends the pen-
alty relates to two partnership items—the shamming of the
partnership, which the Court of Appeals affirmed as the
determination of a partnership item, and the amounts of the
purported partners’ contributions to the partnership.
IV. Court of Appeals’ Opinion
The Court of Appeals held that this Court had no jurisdic-
tion to determine that the outside bases of Petaluma’s part-
ners were zero, as outside basis is an affected item, not a
partnership item. The Court of Appeals then held, inasmuch
as this Court lacked jurisdiction over outside basis, that the
Court also lacked jurisdiction to determine that section 6662
penalties apply with respect to outside basis because
those penalties did not relate to a partnership item. With
respect to other section 6662 penalties, the Court of Appeals
vacated our decision and remanded the case to this Court,
stating:
While it may be that some penalties could have been assessed without
partner-level computations, we cannot affirm a decision that has not yet
been made. Therefore, we vacate the opinion of the Tax Court on the pen-
alties imposition and computation. It may be that upon remand, a deter-
mination can be made for some portion of the penalties, but neither party
has briefed that question before us. [Petaluma FX Partners, LLC v.
Commissioner, 591 F.3d at 656.]
We must now decide whether we have jurisdiction to deter-
mine at the partnership level whether any of the section
6662 penalties apply.
V. Section 6662
The penalties about which jurisdiction is in question all
arise under section 6662. The general rule is that if the sec-
tion applies to any portion of an underpayment of tax, 20
percent of that portion will be added as a penalty. In the case
of a gross valuation misstatement under section 6662(h), the
20-percent penalty is increased to 40 percent. Section 6662(b)
describes the circumstances when the section shall apply and
the penalty is triggered. Respondent asserts three of those
circumstances apply in this case and also asserts all three
relate to partnership-level determinations. They are neg-
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586 135 UNITED STATES TAX COURT REPORTS (581)
ligence under section 6662(b)(1) and (c), substantial under-
statement of income tax under section 6662(b)(2) and (d), and
gross or substantial valuation misstatement under section
6662(b)(3), (e), and (h). The Court of Appeals has agreed with
petitioner’s position that this Court lacks jurisdiction over
penalties that apply with respect to outside basis because
those penalties do not relate to partnership item adjust-
ments. There is a question whether ‘‘outside basis’’ is the cor-
rect term because the partnership has been held to be a
sham, but there clearly are adjustments at the partner level
that will relate to the partners’ bases in assets that they
sold. We are directed that such adjustments are beyond our
jurisdiction and the related penalties are also. See Petaluma
FX Partners, LLC v. Commissioner, 591 F.3d at 655
(‘‘Petaluma argues that since the Tax Court lacked jurisdic-
tion 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. We agree.’’).
VI. Analysis
In this case none of the FPAA adjustments are items that
flow directly to the partner-level deficiency computation as
computational adjustments. Any deficiencies must therefore
be determined against the partners as affected items and
must be resolved in separate partner-level deficiency proce-
dures. The section 6662 penalties are all related to these
adjustments, which have not yet been made by respondent.
The Court of Appeals’ decision addressed the penalty for
substantial valuation misstatement, but on remand
respondent asserts in this partnership-level proceeding that
we have jurisdiction to determine the applicability of the 20-
percent penalty under section 6662(a) and (b)(1) for neg-
ligence on account of our determination that the partnership
is a sham. Respondent does not offer any other issue before
us where a penalty under any subsection of section 6662
could be applied to an adjustment to a specific partnership-
level item. We can find none in the FPAA, the pleadings, or
the stipulation of settled issues.
The determination that the partnership is a sham implies
negligent conduct regarding formation of the partnership, but
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in this case that determination does not trigger a computa-
tional adjustment to taxable income of the partners. The
Court of Appeals declined to allow the general effect of the
partnership determination of sham to confer jurisdiction of
the penalty relating to valuation because the valuation
related to outside basis, an affected item. The Court of
Appeals instructs that for us to have jurisdiction over a pen-
alty at the partnership level it must ‘‘ ‘[relate] to an adjust-
ment to a partnership item.’ ’’ Petaluma FX Partners, LLC v.
Commissioner, 591 F.3d at 655 (quoting section 6226(f)). It
must also be capable of being ‘‘computed without partner-
level proceedings,’’ id., leading at least potentially to only a
computational adjustment to the partners’ returns. The effect
of the mandate concerning the section 6662 penalty is that
if the penalty does not relate directly to a numerical adjust-
ment to a partnership item, it is beyond our jurisdiction. In
this case there are no such adjustments to which a penalty
can apply. The adjustment is an affected item. The sham
determination in this case only indirectly affects basis at the
partner level. There is no partnership item flowing through
to the partners’ returns as a computational adjustment.
Therefore, in accordance with the opinion of the Court of
Appeals, we conclude that we do not have jurisdiction over
any section 6662 penalty determinations in this partnership-
level case.
An appropriate order and decision will
be entered.
Reviewed by the Court.
COLVIN, WELLS, THORNTON, WHERRY, KROUPA, and
HOLMES, JJ., agree with this majority opinion.
GUSTAFSON and MORRISON, JJ., did not participate in the
consideration of this opinion.
HALPERN, J., dissenting: In Petaluma FX Partners, LLC v.
Commissioner, 131 T.C. 84, 103 (2008), affd. in part, revd. in
part, and vacated in part 591 F.3d 649 (D.C. Cir. 2010), we
held that, if a partnership is disregarded for tax purposes, we
have jurisdiction to treat the partners’ outside bases as zero.
We added: ‘‘If a property has a basis of zero, any basis
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588 135 UNITED STATES TAX COURT REPORTS (581)
claimed above that will be a valuation overstatement and the
[section 6662 accuracy-related] penalty will apply.’’ Id. While
the Court of Appeals agreed that, in this partnership-level
proceeding, we have jurisdiction to disregard Petaluma as a
partnership, it disagreed that, on account thereof, we can
find that the partners overstated the value of their bases in
Petaluma. Petaluma FX Partners, LLC v. Commissioner, 591
F.3d at 655. It faulted our determination that the partners
overstated their bases (thus possibly attracting a valuation
misstatement penalty) on the ground that outside basis is an
affected item, which we lack jurisdiction to determine in this
partnership-level proceeding. Id. It questioned whether the
accuracy-related penalty ‘‘could have been computed without
partner-level proceedings to determine the affected-items
questions concerning outside bases’’. Id. at 655–656. It specu-
lated whether any penalty ‘‘could * * * [be] assessed without
partner-level computations,’’ and it remanded for us to again
consider the penalty. Id. at 656. The majority concludes ‘‘that
we do not have jurisdiction over any section 6662 penalty
determinations in this partnership-level case.’’ Majority op. p.
587. I disagree.
Section 6226(f) establishes our jurisdiction in a partner-
ship-level proceeding to determine the applicability of pen-
alties that relate to adjustments to partnership items.
Respondent claims that we have adjusted partnership items
in this partnership-level proceeding by disregarding
Petaluma as a partnership and by redetermining the
amounts of the putative partners’ contributions to it. Because
of those adjustments, respondent asks that we sustain his
assertion of the accuracy-related penalty imposed by section
6662. That penalty is an ad valorem addition imposed on the
portion of an underpayment of tax (to which the section
applies) required to be shown on a tax return. See sec.
6662(a). In this case, the relevant tax returns and underpay-
ments are those of Petaluma’s putative partners because,
although it filed a tax return, Petaluma did so as a partner-
ship, which is a passthrough entity that pays no income tax.
See sec. 701. Respondent’s position is that the putative part-
ners underpaid their income taxes because of adjustments to
partnership items made by this Court and that some or all
of those underpayments are attributable to one or more of
three of the circumstances specified in section 6662(b): Neg-
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(581) PETALUMA FX PARTNERS, LLC v. COMMISSIONER 589
ligence or disregard of rules and regulations (without distinc-
tion, negligence), a substantial understatement of income
tax, and a substantial or gross valuation misstatement. See
sec. 6662(b)(1), (2), and (3).
The term ‘‘affected item’’ includes penalties such as the
section 6662 accuracy-related penalty when the penalty is
imposed on a partner with respect to an adjustment to a
partnership item and the penalty is computed with reference
to the portion of an underpayment in tax attributable to the
adjustment. See sec. 301.6231(a)(5)–1T(d), Temporary
Proced. & Admin. Regs., 52 Fed. Reg. 6790 (Mar. 5, 1987)
(currently, section 301.6231(a)(5)–1(e), Proced. & Admin.
Regs.). The penalty may be applicable here. If Petaluma is
disregarded as a partnership or each putative partner’s con-
tribution to Petaluma is deemed to be zero, one or more
items on each putative partner’s return will change, likely
resulting in a net increase in his tax liability and concomi-
tant underpayment of the tax required to be shown on his
return. 1 If in this proceeding we determine that one or more
of the section 6662(b)(1) through (3) circumstances exist with
respect to an adjustment to a partnership item, then we
should sustain respondent’s determination that the penalty
applies; the penalty is an affected item, and each putative
partner’s liability for the penalty is determined by way of a
computational adjustment. See sec. 301.6231(a)(6)–1T(a),
Temporary Proced. & Admin. Regs., 64 Fed. Reg. 3840 (Jan.
26, 1999) (currently, section 301.6231(a)(6)–1(a), Proced. &
Admin. Regs.). Our decision that the penalty applies is nec-
essarily preliminary, however, since we lack jurisdiction in
this partnership-level proceeding to determine any partner’s
tax liability or underpayment of tax.
In Petaluma FX Partners, LLC v. Commissioner, 131 T.C.
at 103, we concluded that the accuracy-related penalty
applied on the ground of a valuation misstatement of outside
basis. We saw no need to address whether the penalty could
be applied on the grounds of negligence or understatement of
income tax. Id. at 108. As stated, the Court of Appeals
reversed our penalty decision on the ground that outside
basis is an affected item over which, in this proceeding, we
1 I conclude the results are ‘‘likely’’ only because I lack information about the particulars of
the putative partners’ returns and tax liabilities.
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590 135 UNITED STATES TAX COURT REPORTS (581)
lack jurisdiction. It questioned whether the accuracy-related
penalty based on a valuation misstatement could be com-
puted ‘‘without partner-level proceedings to determine the
affected-items questions concerning outside bases’’. Petaluma
FX Partners, LLC v. Commissioner, 591 F.3d at 655–656. It
speculated whether any penalty could be assessed without
partner-level computations. Id. at 656.
Respondent answers the specific question posed by the
Court of Appeals in the affirmative, arguing, alternatively,
(1) ‘‘that the overvaluation penalty applies to any under-
payment of tax that results from the determination that the
partnership is a sham’’ and (2) that it applies ‘‘because * * *
[it] relates to adjustments to inside basis in the contributed
options.’’ With respect to his first alternative, respondent
adds: ‘‘The Court can do this [determine the application of
the penalty] without determining each partner’s outside
basis’’. Respondent adds that, as an alternative to imposing
the accuracy-related penalty on the ground of a valuation
misstatement, the Court could impose the penalty on the
ground of negligence or a substantial understatement of
income tax.
The majority believes that it cannot impose any accuracy-
related penalty because any deficiencies in tax resulting from
this proceeding ‘‘must therefore be determined against the
partners as affected items and must be resolved in separate
partner-level deficiency procedures. The section 6662 pen-
alties are all related to these adjustments, which have not
yet been made by respondent.’’ Majority op. p. 586. While it
is true that the accuracy-related penalty is an ad valorem
addition based on an underpayment of tax, which, in the case
of adjustments to partnership items, may be indeterminable
without a partner-level determination, respondent is here
claiming that the proximate cause of any underpayment
resulting from our adjustments to partnership items is either
a partnership-level misstatement of value, partnership-level
negligence, or the adjustments themselves, which will result
in a substantial understatement of income tax. The majority
appears to accept respondent’s claim of proximate cause:
‘‘The determination that the partnership is a sham implies
negligent conduct regarding formation of the partnership’’.
Majority op. p. 586. Nevertheless, it reads the Court of
Appeals’ questioning of whether a valuation misstatement
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(581) PETALUMA FX PARTNERS, LLC v. COMMISSIONER 591
could be computed without partner-level proceedings to
determine outside basis as establishing a limiting rule: That
for us to have penalty jurisdiction at the partnership level,
not only must the penalty relate to a partnership item (as
plainly required by section 6226(f)), but the penalty also
‘‘must * * * be capable of being ‘computed without partner-
level proceedings,’ * * * leading at least potentially to only
a computational adjustment to the partners’ returns.’’
Majority op. p. 587. Since the accuracy-related penalty is an
ad valorem addition determinable only at the taxpayer (in
this case, partner) level, what the majority must mean is
that a computational adjustment establishing a partner’s
liability for the penalty must be achievable without the
necessity of any partner-level determination. 2 The majority
adds: ‘‘The effect of the mandate concerning the section 6662
penalty is that if the penalty does not relate directly to a
numerical adjustment to a partnership item, it is beyond our
jurisdiction.’’ Majority op. p. 587. Finding no such adjust-
ments, the majority concludes we have no penalty jurisdic-
tion in this case. Majority op. p. 587.
The Court of Appeals does not mention numerical adjust-
ments, and it speaks about the inability to compute the
accuracy-related penalty without partner-level proceedings
only in the context of our attempt to impose the penalty on
account of a valuation misstatement of an affected item; i.e.,
outside basis. Respondent claims that there are grounds for
the penalty that do not require us to determine an affected
item (other than the penalty itself). While the Court of
Appeals does speculate whether a penalty could have been
assessed without a partner-level computation, both the com-
putational adjustment and assessment of any penalty
liability relating to a partnership item are administrative
steps taken only after the close of the partnership-level pro-
ceeding. See sec. 6225(a); sec. 301.6231(a)(6)–1T(a)(2), Tem-
porary Proced. & Admin. Regs., supra (currently, section
301.6231(a)(6)–1(a)(3), Proced. & Admin. Regs.). Moreover,
2 The term ‘‘partner level determination’’ is used in sec. 301.6231(a)(6)–1T(a), Temporary
Proced. & Admin. Regs., 64 Fed. Reg. 3840 (Jan. 26, 1999) (currently, sec. 301.6231(a)(6)–1(a)(1),
Proced. & Admin. Regs.), to describe an intermediate, partner-level determination that, in some
cases, may be necessary before a change in a partner’s tax liability to reflect the treatment of
a partnership item can be made by way of a computational adjustment. The majority appears
to assume that the penalties here in issue cannot be determined without partner-level deter-
minations.
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592 135 UNITED STATES TAX COURT REPORTS (581)
the regulations are clear that a penalty related to a partner-
ship item may be directly assessed following the partnership-
level proceeding ‘‘based on determinations in that proceeding,
regardless of whether partner level determinations are
required.’’ Sec. 301.6231(a)(6)–1T(a)(2), Temporary Proced. &
Admin. Regs., supra (currently, section 301.6231(a)(6)–
1(a)(3), Proced. & Admin. Regs.). The majority’s attribution
to the Court of Appeals of a rule that a computational adjust-
ment to reflect a penalty must be achievable without the
necessity of any partner-level determination flies directly in
the face of other language in that same regulation, which
distinguishes computational adjustments with respect to pen-
alties from other computational adjustments requiring
partner-level determinations:
However, if a change in a partner’s tax liability cannot be made without
making one or more partner level determinations, that portion of the
change in tax liability attributable to the partner level determinations
shall be made under the provisions of subchapter B of chapter 63 of the
Internal Revenue Code (relating to deficiency procedures), except for any
penalty, addition to tax, or additional amount which relates to an adjust-
ment to a partnership item.
Sec. 301.6231(a)(6)–1T(a), Temporary Proced. & Admin.
Regs., supra (emphasis supplied) (currently, section
301.6231(a)(6)–1(a)(1), Proced. & Admin. Regs.). The Court of
Appeals did not undertake to reorganize the procedural steps
established by Congress and implemented by the Secretary
for determining, computing, assessing, and collecting pen-
alties related to partnership items, nor should we interpret
it as doing so.
We obey the Court of Appeals mandate by reconsidering
the section 6662 penalty on grounds (such as those claimed
by respondent) other than those, such as the putative part-
ners’ outside bases, that depend on our determination of an
affected item. Our task, even if we determine that the pen-
alty applies, is necessarily inconclusive, since the penalty is
an affected item, the amount of which is to be determined by
computational adjustment, which may, as a preceding step,
require one or more partner-level determinations. Our juris-
diction extends to the aspects of the penalty we are author-
ized to determine. Nevertheless, in exercise of that jurisdic-
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(581) PETALUMA FX PARTNERS, LLC v. COMMISSIONER 593
tion, we may have to ask respondent to better explain the
grounds he claims justify the penalty.
MARVEL, J., dissenting: The Court of Appeals for the Dis-
trict of Columbia Circuit remanded this case for consider-
ation of whether in this partnership-level proceeding we have
jurisdiction over ‘‘some portion of the penalties’’. See
Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649,
656 (D.C. Cir. 2010) (Petaluma II), affg. in part, revg. in part,
vacating in part and remanding 131 T.C. 84 (2008)
(Petaluma I). The majority concludes that we do not.
Majority op. p. 583. Because I believe that the result the
majority reaches is contrary to sections 6221 and 6226(f) as
amended by the Taxpayer Relief Act of 1997 (TRA 1997), Pub.
L. 105–34, sec. 1238, 111 Stat. 1026, I respectfully dissent.
I. The Court of Appeals Opinion
In Petaluma I we held, among other things, that (1) we
had jurisdiction to decide whether the partnership used to
achieve the challenged tax benefits was a sham and/or lacked
economic substance, (2) we also had jurisdiction to decide
that the partners’ outside bases were overstated because the
partners could not have bases in a disregarded or sham part-
nership, (3) we had jurisdiction over the section 6662
accuracy-related penalty because section 6226(f) gave us
jurisdiction to determine ‘‘the applicability of any penalty,
addition to tax, or additional amount which relates to an
adjustment to a partnership item’’, 1 and (4) a 40-percent
accuracy-related penalty attributable to the gross valuation
misstatement of the partners’ outside bases applied. See
Petaluma I, 131 T.C. 100, 102, 108. In Petaluma II, the
Court of Appeals for the District of Columbia Circuit
affirmed our holding in (1) but reversed our holdings in (2)
and (4), and vacated and remanded ‘‘on the penalties ques-
tion’’. See Petaluma II, 591 F.3d at 656. The Court of
Appeals stated as follows:
1 Although we held we had jurisdiction over the sec. 6662 accuracy-related penalty, we did not
reach the issue of the applicability of any components other than the gross valuation
misstatement component. See Petaluma I, 131 T.C. 100–102.
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594 135 UNITED STATES TAX COURT REPORTS (581)
As it is not clear from the opinion, the record, or the arguments before this
court that the penalties asserted by the Commissioner and ordered by the
Tax Court could have been computed without partner-level proceedings to
determine the affected-items questions concerning outside bases, we are
unable to uphold the court’s determination of the penalty issues. While it
may be that some penalties could have been assessed without partner-level
computations, we cannot affirm a decision that has not yet been made.
Therefore, we vacate the opinion of the Tax Court on the penalties imposi-
tion and computation. It may be that upon remand, a determination can
be made for some portion of the penalties, but neither party has briefed
that question before us. [Id. at 655–656.]
The Court of Appeals remanded ‘‘on the penalties question’’
because it was not clear ‘‘that the penalties asserted by the
Commissioner and ordered by the Tax Court could have been
computed without partner-level proceedings to determine the
affected-items questions concerning outside bases’’. Id. The
Court of Appeals acknowledged the possibility that on
remand a determination could be made ‘‘for some portion of
the penalties’’. Id. at 656.
II. The Section 6662 Penalty in Petaluma
A. In General
Although respondent’s primary argument under section
6662 is that a 40-percent accuracy-related penalty applies
because of a gross valuation misstatement, he also asserted
in the FPAA a 20-percent accuracy-related penalty attrib-
utable to negligence or to a substantial understatement of
income tax. The application of any of these components of the
accuracy-related penalty involves the juxtaposition of section
6662, the Tax Equity and Fiscal Responsibility Act of 1982
(TEFRA), Pub. L. 97–248, sec. 402, 96 Stat. 648, and amend-
ments to TEFRA by TRA 1997. To better understand the scope
of our jurisdiction over the section 6662 penalty in partner-
ship-level TEFRA cases, an overview of TEFRA and the TRA
1997 amendments is helpful.
B. TEFRA Litigation Structure
Before 1982 partnership tax issues were raised and liti-
gated at the partner level, resulting in bloated caseloads and
duplicative litigation of partnership issues. See Domulewicz
v. Commissioner, 129 T.C. 11, 17 (2007), affd. in part and
remanded in part on other grounds sub nom. Desmet v.
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Commissioner, 581 F.3d 297 (6th Cir. 2009). In an effort to
eliminate the perceived inefficiencies, the waste of resources,
and the potential for inconsistent results among partners on
the same partnership issues that could result from duplica-
tive litigation at the partner level, Congress, at the Depart-
ment of the Treasury’s request, enacted the unified partner-
ship audit and litigation provisions as part of TEFRA. See id.
The provisions were constructed around a simple premise—
although a partnership is not an entity that is liable for Fed-
eral income tax, partnership tax issues ordinarily must be
resolved in a single proceeding at the partnership level. See
id. at 17–18.
The basic structure of partnership litigation under TEFRA
is easy to understand. Section 6221 provides that the tax
treatment of any partnership item ‘‘shall be determined at
the partnership level.’’ 2 Section 6222(a) provides that a
partner, on the partner’s return, shall treat a partnership
item in a manner consistent with the treatment of the item
on the partnership return. If the Commissioner audits the
partnership return and determines that adjustments to part-
nership items are necessary, he must issue an FPAA to the
partnership (through the tax matters partner) and send a
copy of the FPAA to all partners who are entitled to notice.
See sec. 6223(a)(2).
The tax matters partner or a partner/partners with a large
enough partnership interest may file a petition for judicial
review of the FPAA within certain time limits. Sec. 6226(a)
and (b). A court with which a petition is filed has jurisdiction
‘‘to determine all partnership items of the partnership for the
partnership taxable year to which the * * * [FPAA] relates
and the proper allocation of such items among the partners.’’
Sec. 6226(f), I.R.C. 1996 (before amendment by TRA 1997).
After the restrictions on assessment and collection under
section 6225 no longer apply, the Commissioner is authorized
2 Partnership items are items required to be taken into account for the partnership’s taxable
year to the extent that those items are more appropriately determined at the partnership level
than at the partner level. See sec. 6231(a)(3). Nonpartnership items that are affected by adjust-
ments to partnership items are called ‘‘affected items’’. Sec. 6231(a)(5). There are two types of
affected items: (1) Items that require factual determinations to be made at the partner level,
and (2) items that require merely a computational adjustment, such as the amount of a medical
expense deduction under sec. 213(a). See N.C.F. Energy Partners v. Commissioner, 89 T.C. 741,
744–745 (1987). The former group, the ‘‘substantive’’ affected items, has not only a computa-
tional element but also a substantive element in that a court must consider evidence and find
facts regarding the affected item in an affected items deficiency proceeding.
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596 135 UNITED STATES TAX COURT REPORTS (581)
to make computational adjustments to the partners’ tax
liabilities to reflect the adjustment of partnership items in
the partnership-level proceeding. Sec. 6231(a)(6) (definition of
computational adjustment); sec. 301.6231(a)(6)–1T(a), Tem-
porary Proced. & Admin. Regs., 64 Fed. Reg. 3840 (Jan. 26,
1999). The deficiency procedures do not apply to the assess-
ment or collection of any computational adjustment unless
the computational adjustment involves a deficiency attrib-
utable to an affected item that requires a partner-level deter-
mination or to items that have become nonpartnership items.
Sec. 6230(a)(1) and (2). If the computational adjustment
involves a deficiency attributable to an affected item that
requires a partner-level determination, the Commissioner
must issue an affected items notice of deficiency to the
partner. Sec. 6230(a)(2). Accordingly, there are two types of
computational adjustments paralleling two types of affected
items: (1) Purely mathematical computational adjustments
that do not require partner-level determinations and may be
directly assessed, 3 see sec. 6230(a)(1); sec. 301.6231(a)(6)–
1T(a)(1), Temporary Proced. & Admin. Regs., supra, and (2)
adjustments that require partner-level determinations and
are therefore subject to deficiency procedures, see sec.
6230(a)(2); sec. 301.6231(a)(6)–1T(a)(2), Temporary Proced. &
Admin. Regs., supra. After the Commissioner issues an
affected items notice of deficiency, generally the partner may
file a Tax Court petition to contest it. See sec. 6213. Alter-
natively, the partner can pay the affected item deficiency, file
a claim for refund, and then bring a refund action. See 28
U.S.C. sec. 1346(a)(1) (2006).
The devil, of course, is in the details, and sections 6221–
6233, as originally enacted, raised many difficult interpretive
issues that occupied this Court and others for years after
TEFRA was enacted. For example, it became apparent in prac-
tice that the litigation procedures as originally enacted did
not adequately address how penalties and additions to tax
that might require partner-level determinations fit into the
partnership litigation regime. 4 Congress took notice and
3 There is no prepayment forum for contesting the accuracy of such adjustments. However, if
an affected item deficiency proceeding is pending, the Tax Court may extend its overpayment
jurisdiction to consider computational adjustments that have been assessed and paid. See, e.g.,
Barton v. Commissioner, 97 T.C. 548 (1991) (overpayment jurisdiction applied).
4 For example, in Maxwell v. Commissioner, 87 T.C. 783, 790, 793 (1986), a reviewed Opinion,
this Court held that additions to tax and investment tax credit carrybacks were ‘‘affected items’’
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(581) PETALUMA FX PARTNERS, LLC v. COMMISSIONER 597
began tweaking the TEFRA provisions to fill gaps in the proce-
dures and make them work better. Two such adjustments
occurred when Congress, as part of the Tax Reform Act of
1986, Pub. L. 99–514, sec. 1875(d), 100 Stat. 2896, enacted
technical corrections to TEFRA that included (1) adding new
section 6229(g), which extended the period of limitations on
assessment with respect to additions to tax affected by
adjustments to partnership items, and (2) amending section
6230(a) to permit the Commissioner to issue an affected
items notice of deficiency. The most relevant adjustments for
purposes of this case, however, occurred in 1997 when Con-
gress enacted TRA 1997.
C. TRA 1997
Before the enactment of TRA 1997, penalties and additions
to tax were classified as affected items and issues regarding
such items were litigated in a partner-level deficiency pro-
ceeding regardless of whether they related to adjustments to
partnership items. See, e.g., N.C.F. Energy Partners v.
Commissioner, 89 T.C. 741, 744–745 (1987). TRA 1997
amended section 6221 to provide that a penalty or addition
to tax ‘‘which relates to an adjustment to a partnership item’’
must be determined at the partnership level. TRA 1997 also
amended section 6226(f) to provide that a court with jurisdic-
tion over a partnership-level proceeding had jurisdiction over
a penalty or addition to tax ‘‘which relates to an adjustment
to a partnership item’’. See sec. 6226(f). Among other impor-
tant changes was the change to section 6230(a)(2)(A)(i),
which was amended to read as follows:
SEC. 6230. ADDITIONAL ADMINISTRATIVE PROVISIONS.
(a) COORDINATION WITH DEFICIENCY PROCEEDINGS.—
(1) IN GENERAL.—Except as provided in paragraph (2) or (3), sub-
chapter B of this chapter[5] shall not apply to the assessment or collec-
tion of any computational adjustment.
(2) DEFICIENCY PROCEEDINGS TO APPLY IN CERTAIN CASES.—
(A) Subchapter B shall apply to any deficiency attributable to—
that must be dismissed from a deficiency proceeding to await the outcome of pending partner-
ship proceedings.
5 Subch. B (secs. 6211 through 6216) contains the provisions authorizing the Commissioner
to issue notices of deficiency and provides the Tax Court with jurisdiction to redetermine those
deficiencies.
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598 135 UNITED STATES TAX COURT REPORTS (581)
(i) affected items which require partner level determinations
(other than penalties, additions to tax, and additional amounts that
relate to adjustments to partnership items) * * *
Finally, TRA 1997 provided 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.’’ Sec.
6230(c)(1)(C).
As described, under the TEFRA provisions as amended by
TRA 1997, penalties and additions to tax are treated dif-
ferently from other affected items. The net effect of the TRA
1997 changes is that deficiency procedures no longer apply to
penalties and additions to tax related to adjustments to part-
nership items, even if they require factual determinations at
the partner level. Sec. 6230(a)(2)(A)(i); Domulewicz v.
Commissioner, 129 T.C. 23; Fears v. Commissioner,
129
T.C. 8 (2007). Although the Court has jurisdiction in a part-
nership-level proceeding to consider whether the penalty
attributable to an adjustment to a partnership item applies,
it has no jurisdiction to decide the amount of the penalty or
consider partner-level defenses. Cf. Domulewicz v. Commis-
sioner, supra at 23.
D. The Interaction of Section 6662(a) and TEFRA
In Petaluma, as in most typical Son-of-BOSS cases,
respondent alleged alternative positions with respect to the
section 6662 penalty in the FPAA. Respondent’s primary posi-
tion was that the 40-percent accuracy-related penalty applied
because of a gross valuation misstatement of something, 6
6 Generally, the valuation misstatement penalty applies if there is a misstatement of value
or basis of property on a return. See sec. 6662(e). In the Petaluma FPAA, respondent adjusted
the following items to zero: Capital contributions, distributions of property other than money,
outside partnership basis, and the partners’ capital accounts. All of these items involve a state-
ment of property value or basis, and all of the items, except outside partnership basis, are part-
nership items. In pertinent part, the FPAA stated as follows:
The formation of Petaluma FX Partners, LLC, the acquisition of any interest in the purported
partnership by the purported partner, the purchase of offsetting options, the transfer of offset-
ting options to a partnership in return for a partnership interest, the purchase of assets by the
partnership, and the distribution of those assets to the purported partners in complete liquida-
tion of the partnership interests, and the subsequent sale of those assets to generate a loss, had
no business purpose other than tax avoidance, lacked economic substance, and, in fact and sub-
stance, constitutes (sic) an economic sham for federal income tax purposes. Accordingly, the
partnership and the transaction 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.
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and his alternative or additional position was that the 20-
percent accuracy-related penalty attributable to negligence or
substantial understatement of income tax applied.
Generally, section 6662(a) authorizes the imposition in
appropriate cases of an accuracy-related penalty that poten-
tially comprises several components. The penalty applies to
‘‘any portion of an underpayment of tax required to be shown
on a return’’, sec. 6662(a), if the underpayment or a portion
thereof is attributable to one or more of the following: (1)
Negligence or disregard of rules and regulations, (2) any
substantial understatement of income tax, (3) any substan-
tial valuation misstatement, (4) any substantial overstate-
ment of pension liabilities, and (5) any substantial estate or
gift tax valuation understatement, sec. 6662(b). It is possible
that a portion of an underpayment is attributable to one
component, e.g., negligence, while another portion of the
underpayment is attributable to a different component, e.g.,
gross or substantial valuation misstatement. 7 The section
6662(a) penalty is an ad valorem penalty, and its amount
ultimately depends on the amount of tax underpayment.
The seemingly simple concept of penalty calculations, how-
ever, does not fit well in the context of TEFRA because part-
nerships are accounting mechanisms and are not subject to
Federal income tax. See sec. 701. The section 6662 penalty,
on the other hand, applies to a ‘‘portion of an underpayment’’.
(Emphasis added.) The term ‘‘underpayment’’ is a defined
term 8 and presupposes tax shown on the return or tax pre-
viously assessed or collected. See sec. 6664(a). For this rea-
son, the amount of the penalty cannot be calculated without
reference to the taxpayer’s return, and the relevant return
for purposes of the penalty calculation is the partner’s
return.
7 The alternative components of the sec. 6662 penalty cannot be stacked, and the maximum
accuracy-related penalty imposed on a portion of an underpayment may not exceed 20 percent
of such portion (or 40 percent of the portion attributable to a gross valuation misstatement),
even if such portion is attributable to more than one type of misconduct described in sec.
6662(b). See sec. 1.6662–2(c), Income Tax Regs.
8 Sec. 6664(a) provides:
SEC. 6664(a). UNDERPAYMENT.—For purposes of this part, the term ‘‘underpayment’’ means
the amount by which any tax imposed by this title exceeds the excess of—
(1) the sum of—
(A) the amount shown as the tax by the taxpayer on his return, plus
(B) amounts not so shown previously assessed (or collected without assessment), over
(2) the amount of rebates made.
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600 135 UNITED STATES TAX COURT REPORTS (581)
As follows from the foregoing, the section 6662 partner-
ship-level penalty cannot be calculated and assessed until a
computational adjustment 9 is made to a partner’s tax
liability and the underpayment of tax on the partner’s return
is calculated. Because of the TEFRA partnership litigation
structure, such calculation of the underpayment takes place
after the partnership-level proceeding and/or partner-level
affected items deficiency proceedings are completed.
The sequence of the penalty applicability determination at
the partnership level and the subsequent calculation of the
underpayment and penalty amounts creates further
incongruities when a particular component of the penalty has
a statutory floor. For example, the substantial or gross valu-
ation misstatement component of the penalty applies only if
the portion of the underpayment for the year that is attrib-
utable to substantial or gross valuation misstatements
exceeds $5,000 ($10,000 in the case of a corporation other
than an S corporation). See sec. 6662(e)(2); sec. 1.6662–5(b),
Income Tax Regs. In the case of a return of a partnership or
another pass-through entity, the determination of whether
there is a substantial or gross valuation misstatement is
made at the entity level. See sec. 1.6662–5(h)(1), Income Tax
Regs. However, the dollar limitation ($5,000 or $10,000, as
might be applicable), is applied at the taxpayer level, and the
underpayment is calculated by reference to the partner
return. See id. Accordingly, although it is possible that a
statutory floor will ultimately not be met, the determination
that a penalty applies nevertheless must be made at the
partnership level, see secs. 6221, 6226(f), 6230(a)(2)(A)(i), and
is necessarily conditioned upon a later verification that the
statutory floor is met. That verification flows automatically
from the recalculation of the partner’s tax liability and is
reflected in the resulting computational adjustment that is
made to the partner’s tax liability at the end of the partner-
ship-level proceeding and/or the partner-level affected items
deficiency proceeding. A similar scenario arises with respect
to the substantial understatement component under section
6662(a), (b)(2), and (d).
9 A computational adjustment is the change in the tax liability of a partner which properly
reflects the treatment of a partnership item. See sec. 6231(a)(6).
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(581) PETALUMA FX PARTNERS, LLC v. COMMISSIONER 601
As a consequence and in contrast to what occurs in defi-
ciency cases, a peculiarity of TEFRA cases is that when a
court enters a decision in the partnership-level proceeding
stating that a section 6662(a) penalty applies, neither the
amount of the penalty nor its allocation among partners is
known until after the underpayment is calculated at the
partner level. In fact, even if the court determines that the
penalty applies, the amount of the penalty might be zero if
the statutory floor is not met in the case of the substantial
understatement and valuation misstatement components or
if there is no underpayment by a partnership’s partner. See,
e.g., sec. 1.6662–5(b), Income Tax Regs. Nevertheless, under
TRA 1997 the penalty that ‘‘relates to an adjustment to a
partnership item’’ must be determined at the partnership
level. 10 See sec. 6221.
III. Negligence in This Case
The majority holds that we have no jurisdiction over any
component of the penalty in this case. I believe we have
jurisdiction to determine that the section 6662 penalty attrib-
utable to negligence applies. 11 That penalty rests on the
determination that the Petaluma partnership was a sham
and is not recognized for Federal tax purposes and that all
of the transactions in which it engaged, which were inter-
related and preordained, were the result of negligence at the
entity level. No other factual determinations need be made
at the partner level to determine that the
mischaracterization of Petaluma as a partnership for Federal
income tax purposes and its claim that it received contribu-
tions of property from its partners and made distributions of
10 The legislative history of TRA 1997 indicates that Congress amended secs. 6221, 6226(f),
and 6230(a)(2)(A)(i) to lessen administrative burdens on the Commissioner and the courts and
to require that culpability for a penalty or addition to tax be litigated at the level on which the
relevant conduct occurs:
Many penalties are based upon the conduct of the taxpayer. With respect to partnerships, the
relevant conduct often occurs at the partnership level. In addition, applying penalties at the
partner level through the deficiency procedures following the conclusion of the unified pro-
ceeding at the partnership level increases the administrative burden on the IRS and can signifi-
cantly increase the Tax Court’s inventory.
H. Rept. 105–148, at 594 (1997), 1997–4 C.B. (Vol. 1) 319, 916.
11 The substantial understatement component of the penalty under sec. 6662(a), (b)(2), and (d)
would also apply if the statutory floor is met. Petitioner does not contend that the partnership
had substantial authority or adequately disclosed the transaction. See sec. 6662(d)(2)(B); sec.
1.6662–4(f)(5), Income Tax Regs. (providing that disclosure in the case of items attributable to
a pass-through entity is made with respect to the entity return).
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602 135 UNITED STATES TAX COURT REPORTS (581)
property to its partners were negligent. Accordingly, what-
ever underpayment results from the nonexistence of the part-
nership and the adjustment to Petaluma’s partnership
status, which is a partnership item, is attributable to neg-
ligence at the partnership level.
As stated above, a penalty must be determined in a part-
nership-level proceeding if (1) it relates (2) to an adjustment
(3) of a partnership item. See secs. 6221, 6226(f). The deter-
minations that the Petaluma partnership was a sham, lacked
economic substance, and should be disregarded for tax pur-
poses are determinations of partnership items, and we have
jurisdiction under section 6226(f) to decide them in a part-
nership-level proceeding. Petaluma II, 591 F.3d at 654. The
determination that the partnership should be disregarded or
that it, or the transactions in which it engaged, had no eco-
nomic substance is an ‘‘adjustment’’ to a partnership item,
and that is confirmed by a review of the FPAA. Consistent
with respondent’s determination that Petaluma was a sham
for Federal tax purposes, the FPAA adjusted all partnership
items, including contributions made by the partners and dis-
tributions made to the partners, claimed on the partnership
return to zero.
The critical interpretive issue under sections 6221, 6226(f),
and 6230(a)(2)(A)(i) is whether the section 6662 penalty
‘‘relates to’’ an adjustment of a partnership item. The
majority does not interpret the phrase ‘‘relates to’’ but in
effect applies it overly narrowly. Generally, words in revenue
legislation should be interpreted according to their ordinary,
everyday meaning. Fort Howard Corp. & Subs. v. Commis-
sioner, 103 T.C. 345, 351 (1994) (citing Commissioner v.
Soliman, 506 U.S. 168, 174 (1993)). ‘‘Relate’’ means, inter
alia, ‘‘to show or establish logical or causal connection’’.
Merriam Webster’s Collegiate Dictionary 984 (10th ed. 1997).
‘‘Related’’ means, inter alia, ‘‘being connected; associated.’’
The American Heritage Dictionary of the English Language
1473 (4th ed. 2000). There is a logical and causal relationship
between the determination of sham (a partnership item) and
the computational adjustments such determination produces
at the partner level. Because the negligence component of the
accuracy-related penalty relates to an adjustment to a part-
nership item (shamming of the partnership), we have juris-
diction under section 6226(f) to decide whether the accuracy-
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(581) PETALUMA FX PARTNERS, LLC v. COMMISSIONER 603
related penalty attributable to negligence applies at the part-
nership level, and I would so hold. 12
The majority states: ‘‘The effect of the mandate concerning
the section 6662 penalty is that if the penalty does not relate
directly to a numerical adjustment to a partnership item, it
is beyond our jurisdiction.’’ Majority op. p. 587. The majority
thus requires that (1) a penalty directly relate to an adjust-
ment, and (2) a numerical adjustment to a partnership item
be the only type of partnership item adjustment invoking our
penalty jurisdiction. Neither ‘‘directly’’ nor ‘‘numerical’’
appears in section 6226(f), which gives us jurisdiction to
‘‘determine * * * the applicability of any penalty, addition to
tax, or additional amount which relates to an adjustment to
a partnership item.’’ Section 6226(f) does not require that the
penalty directly relate to an adjustment, nor does it distin-
guish between numerical and nonnumerical adjustments to a
partnership item. In addition, the Petaluma FPAA contains
both numerical adjustments, which are set forth in a
Schedule of Adjustments, and the narrative Explanation of
Items. The determination that the partnership was a sham
is contained in the Explanation of Items and is reflected at
least in part by the numerical adjustments to specific part-
nership items like partners’ capital contributions and partner
distributions, which are reduced to zero.
The majority also states:
In this case none of the FPAA adjustments are items that flow directly
to the partner-level deficiency computation as computational adjustments.
Any deficiencies must therefore be determined against the partners as
affected items and must be resolved in separate partner-level deficiency
procedures. The section 6662 penalties are all related to these adjust-
ments, which have not yet been made by respondent. [Majority op. p. 586.]
12 Petitioner does not contest or disagree with the finding that the partnership was a sham.
In fact, petitioner has conceded the applicability of the 20-percent accuracy-related penalty for
either negligence or substantial understatement of income tax in the event that the higher 40-
percent accuracy-related penalty for gross valuation misstatement does not apply. Petitioner is
contesting only our jurisdiction to determine the sec. 6662 penalty for negligence. The parties
stipulated:
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 under-
payment resulting from the adjustments to partnership items.
Although petitioner argues on remand that no component of the accuracy-related penalty ap-
plies, the argument seems to be an opportunistic grab for penalty relief on the basis of Petaluma
II.
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604 135 UNITED STATES TAX COURT REPORTS (581)
I interpret this statement to mean that our jurisdiction over
the section 6662 penalty at the partnership level depends on
whether the adjustment of a partnership item results
in a computational adjustment that is directly assessed. I
disagree with that statement because our jurisdictional grant
under section 6226(f) is not so limited. Section 6226(f)
unequivocally provides that we have jurisdiction to decide
whether a penalty applies if it relates to an adjustment of a
partnership item. In a Son-of-BOSS case like Petaluma, a tax-
payer engages in a set of preordained and interrelated trans-
actions to achieve an artificial and inflated tax loss. The use
of a transient partnership is essential because the partner-
ship enables the taxpayer-partner to ultimately claim the
disputed loss. In the Petaluma version of Son-of-BOSS, the
partners contributed pairs of offsetting options to the part-
nership. See Petaluma II, 591 F.3d at 650. When the part-
ners withdrew from the partnership 2 months later,
Petaluma liquidated their interests in the partnership by dis-
tributing cash and shares of Scient stock. Id. The partners
then sold the distributed Scient stock and claimed
an inflated basis in the stock to calculate the loss. Id. The
inflated basis in the stock was (purportedly) possible only
because of the partnership vehicle. Because of the inter-
relationship of the transactions and the interplay of the basis
rules of subchapter K, the ultimate disallowance of the part-
ner’s loss is related to the adjustments to partnership items
resulting from the partnership-level proceeding. It follows
that we have jurisdiction to decide whether the section 6662
penalty attributable to negligence applies. Sec. 6226(f).
The accuracy-related penalty asserted in the Petaluma
FPAA (other than the substantial valuation component of the
penalty over which the Court of Appeals in Petaluma II held
we had no jurisdiction) relates to the shamming of the part-
nership and to the resulting adjustments to partnership
items such as contributions and distributions. The conduct
that is being sanctioned occurred at the partnership level.
The Petaluma partners could not have achieved the pur-
ported loss without the transient existence of the partner-
ship. The section 6662 penalty with respect to the partner-
ship misconduct must be determined at the partnership level.
Secs. 6221, 6226(f); see also Domulewicz v. Commissioner,
129 T.C. 20–21.
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(581) PETALUMA FX PARTNERS, LLC v. COMMISSIONER 605
The majority relegates the issue of negligence at the part-
nership level to an affected items deficiency proceeding. That
action is foreclosed by section 6230(a)(2)(A)(i), as amended by
TRA 1997. As discussed above, under section 6230(a)(2)(A)(i),
penalties, additions to tax, and additional amounts that
relate to adjustments to partnership items no longer are sub-
ject to deficiency procedures. Although Congress recognized
that a penalty related to an adjustment to a partnership item
might require partner-level determinations, Congress never-
theless explicitly excepted the determination of such pen-
alties from the deficiency provisions by amending section
6230(a)(2)(A)(i). Temporary regulations under section 6231
take a similar approach. See sec. 301.6231(a)(6)–1T(a)(2),
Temporary Proced. & Admin. Regs., supra (‘‘any penalty,
addition to tax, or additional amount that relates to an
adjustment to a partnership item may be directly assessed
following a partnership proceeding, based on determinations
in that proceeding, regardless of whether partner level deter-
minations are required’’).
For these reasons, I would hold that we have jurisdiction
to decide that the accuracy-related penalty attributable to
negligence applies at the partnership level. 13
COHEN, GALE, and PARIS, JJ., agree with this dissent.
f
13 In my opinion, a finding of negligence at the partnership level in a Son-of-BOSS case such
as Petaluma does not preclude a finding of partner-level negligence. That is because of the
unique nature of many Son-of-BOSS transactions, which require partnership level and partner-
level actions to generate the loss. Notably, respondent took the positions in the FPAA that ‘‘Ac-
curacy Penalties under IRC Section 6662 are included as a partnership level determination’’ and
‘‘I.R.C. Penalty 6662 is applicable at the individual partner level and may be raised in separate
proceedings at the partner level following the present partnership proceeding.’’ I interpret these
seemingly contradictory statements to mean that a sec. 6662 penalty is asserted and may apply
to both partnership-level conduct (such as claiming that a valid partnership existed) and to part-
ner-level conduct (such as claiming an inflated outside basis for the property distributed by the
partnership and sold by the partner).
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