Highpoint Tower Technology Inc. v. Commissioner of Internal Revenue , 931 F.3d 1050 ( 2019 )

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[PUBLISH]
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT
________________________
No. 18-10394
________________________
Agency No. 2828-16
HIGHPOINT TOWER TECHNOLOGY INC.,
Petitioner - Appellant,
versus
COMMISSIONER OF INTERNAL REVENUE,
Respondent - Appellee.
________________________
Petition for Review of a Decision of the
U.S. Tax Court
________________________
(July 24, 2019)
Before ED CARNES, Chief Judge, ANDERSON and JULIE CARNES, Circuit
Judges.
ANDERSON, Circuit Judge:
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This is an appeal by Highpoint Tower Technology, Inc. (“Highpoint”) of the
Tax Court’s denial of its Motion to Restrain Collection of the gross valuation-
misstatement penalty, I.R.C. § 6662(h)(1), which was determined to be applicable
during relevant partnership proceedings.1 The issue in this case is whether, under
the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”), 2 a Tax Court
presiding over partner-level deficiency proceedings has jurisdiction over a gross
valuation-misstatement penalty previously determined to be applicable at the
partnership level where the partnership was determined to be a “sham” and
“lacking economic substance.” The Internal Revenue Code, as in effect during the
relevant time, applicable regulations, and Supreme Court precedent make clear that
the valuation-misstatement penalty at issue here relates to an adjustment to a
1
Although the Tax Court’s order did not resolve all pending claims, we have appellate
jurisdiction over this interlocutory appeal pursuant to I.R.C. § 7482(a)(3), authorizing an
immediate appeal of “[a]n order of the Tax Court which is entered under authority of I.R.C.
§ 6213(a) and which resolves a proceeding to restrain assessment or collection.” Section 6213(a)
authorizes the Tax Court to enjoin any premature assessment or collection and is treated as a
decision of the Tax Court “subject to the same review by the United States Court of Appeals as a
similar order of a district court.” § 7482(a)(3).
2
This case focuses on the 1997 amendments to TEFRA. Taxpayer Relief Act of 1997,
Pub. L. No. 105-34, § 1238(a), 111 Stat. 788, 1026–27. The TEFRA partnership procedures
applicable in this case were prospectively repealed by the Bipartisan Budget Act of 2015, Pub. L.
No. 114-74, § 1101(a), 129 Stat. 584, 625, effective for taxable years beginning on or after
January 1, 2018. Unless otherwise indicated, all United States Code and Treasury Regulations
cited in this opinion refer to those in effect at the time in question, namely the time of Highpoint
filing its return.
We recognize that our decision in this case will have little impact with respect to taxable
years beginning on or after January 1, 2018. However, the instant dispute suggests that our
decision may well be relevant for several years until disputes with respect to taxable years
beginning before January 1, 2018 have all been resolved.
2
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partnership item and, consequently, is explicitly excluded from the Tax Court’s
deficiency jurisdiction. We hold that a Tax Court presiding over partner-level
deficiency proceedings does not have jurisdiction over gross valuation-
misstatement penalties imposed against a partnership previously determined to be a
“sham” and “lacking economic substance.” We accordingly affirm the Tax
Court’s order denying taxpayer’s Motion to Restrain Collection to the extent it
related to the gross valuation-misstatement penalty.
I. BACKGROUND
A. Factual Background
This case involves a tax shelter known as “Son-of-BOSS.” “Like many of
its kin, this tax shelter employs a series of transactions to create artificial financial
losses that are used to offset real financial gains, thereby reducing tax liability.”
Petaluma FX Partners, LLC v. Comm’r, 591 F.3d 649, 650 (D.C. Cir. 2010),
abrogated on other grounds by United States v. Woods, 571 U.S. 31, 134 S. Ct.
557 (2013).
There are a number of different types of Son-of-BOSS transactions,
but what they all have in common is the transfer of assets encumbered
by significant liabilities to a partnership, with the goal of increasing
basis in that partnership. The liabilities are usually obligations to buy
securities, and typically are not completely fixed at the time of
transfer. This may let the partnership treat the liabilities as uncertain,
which may let the partnership ignore them in computing basis. If so,
the result is that the partners will have a basis in the partnership so
great as to provide for large—but not out-of-pocket—losses on their
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individual tax returns. Enormous losses are attractive to a select
group of taxpayers—those with enormous gains.
Kligfeld Holdings v. Comm’r, 128 T.C. 192, 194 (2007); see also I.R.S. Notice
2000–44, 2000–2 C.B. 255.
In 1999, Highpoint joined Arbitrage Trading, LLC (“Arbitrage”) as a
partner. In exchange for a membership interest in Arbitrage, Highpoint contributed
$62,500 in cash and a pair of Euro options that it had purchased from AIG
International, Inc. By disregarding the potential obligations under the Euro options
as a potential liability, Highpoint reported its outside basis as $13,295,980. A few
months after entering the partnership, Highpoint withdrew in exchange for a
liquidated distribution of the Euros. It then sold the Euros and reported a related
capital loss of $13,111,783 on its 1999 federal income tax return.
B. Procedural Background
Before outlining the legal proceedings that ensued after Highpoint filed its
1999 income tax return reflecting artificial losses generated by its participation in
this tax shelter, we first pause to outline the statutory framework governing
taxation of partnerships at the time in question. After this overview, we outline the
partnership-level proceedings concerning Arbitrage and the partner-level
proceedings concerning Highpoint that have spanned the twenty years or so since
Highpoint filed its income tax return reporting the losses at issue, which ultimately
resulted in this appeal.
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1. Overview of statutory scheme
“A partnership does not pay federal income taxes; instead, its taxable
income and losses pass through to the partners.” United States v. Woods, 571 U.S.
31, 38, 134 S. Ct. 557, 562 (2013) (citing I.R.C. § 701). Partnerships file
informational returns, § 6031(a), and individual partners report their shares of the
partnership’s income or losses on their respective income tax returns, § 702. Prior
to TEFRA
the IRS had no way of correcting errors on a partnership’s return in a
single, unified proceeding. Instead, tax matters pertaining to all the
members of a partnership were dealt with just like tax matters
pertaining only to a single taxpayer: through deficiency proceedings at
the individual-taxpayer level. See generally §§ 6211–6216 (2006 ed.
and Supp. V). Deficiency proceedings require the IRS to issue a
separate notice of deficiency to each taxpayer, § 6212(a) (2006 ed.),
who can file a petition in the Tax Court disputing the alleged
deficiency before paying it, § 6213(a). Having to use deficiency
proceedings for partnership-related tax matters led to duplicative
proceedings and the potential for inconsistent treatment of partners in
the same partnership. Congress addressed those difficulties by
enacting [TEFRA]. 96 Stat. 648 (codified as amended at 26 U.S.C.
§§ 6221–6232 (2006 ed. and Supp. V)).
Woods, 571 U.S. at 38, 134 S. Ct. at 562–63. TEFRA created a two-step process
for addressing partnership-related tax matters:
First, the IRS must initiate proceedings at the partnership level to
adjust “partnership items,” those relevant to the partnership as a
whole. §§ 6221, 6231(a)(3). It must issue [a Final Partnership
Administrative Adjustment] notifying the partners of any adjustments
to partnership items, § 6223(a)(2), and the partners may seek judicial
review of those adjustments, § 6226(a)–(b). Once the adjustments to
partnership items have become final, the IRS may undertake further
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proceedings at the partner level to make any resulting “computational
adjustments” in the tax liability of the individual partners.
§ 6231(a)(6). Most computational adjustments may be directly
assessed against the partners, bypassing deficiency proceedings and
permitting the partners to challenge the assessments only in post-
payment refund actions. § 6230(a)(1), (c). Deficiency proceedings
are still required, however, for certain computational adjustments that
are attributable to “affected items,” that is, items that are affected by
(but are not themselves) partnership items. §§ 6230(a)(2)(A) (i),
6231(a)(5).
Id. at 39, 134 S. Ct. at 563. With this framework in mind, we next outline the
partnership-level proceedings concerning Arbitrage.
2. Partnership-level proceedings
In October 2005, the IRS issued a Notice of Final Partnership
Administrative Adjustment (“FPAA”) to Arbitrage, proposing adjustments to
partnership items for the 1999 tax year. The FPAA reported that the IRS had
determined that Arbitrage “was formed and availed of solely for the purposes of
tax avoidance by artificially overstating basis in the partnership interests of its
purported partners.” The IRS had determined that Arbitrage “was a sham” and
“lacked economic substance.” Accordingly, the IRS had determined that (a)
Arbitrage would be disregarded and all transactions engaged in by the purported
partnership would be treated as engaged in directly by its purported partners; (b)
the foreign currency options would be treated as if never contributed to Arbitrage;
(c) the purported partners would not be treated as partners of Arbitrage; and (d)
contributions to Arbitrage would be adjusted to reflect the partnership’s or
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purported partner’s income. Purported partners were determined to have “not
established adjusted bases in their respective partnership interests in an amount
greater than zero.” The IRS further determined, among other things, that “a 40
percent penalty shall be imposed on the portion of any underpayment attributable
to the gross valuation misstatement.”
I.R.C. § 6662(a) imposes a 20% accuracy-related penalty to the portion of
underpaid tax attributable to, among other things, negligence, any substantial
understatement of income tax, or any substantial valuation misstatement.
§ 6662(a), (b)(1)–(3). The penalty increases to 40% if there is a gross valuation
misstatement. § 6662(h)(1). “A gross valuation misstatement exists if ‘the value
of any property (or the adjusted basis of any property) claimed on any return of
tax . . . is [400] percent or more of the amount determined to be the correct amount
of such valuation or adjusted basis (as the case may be).’” Gustashaw v. C.I.R.,
696 F.3d 1124, 1135 (11th Cir. 2012) (citing § 6662(e)(1)(A), (h)(2)(A)(i)). A
treasury regulation relatedly provides:
The value or adjusted basis claimed on a return of any property
with a correct value or adjusted basis of zero is considered to be 400
percent or more of the correct amount. There is a gross valuation
misstatement with respect to such property, therefore, and the
applicable penalty rate is 40 percent.
26 C.F.R. § 1.6662-5(g); see also Gustashaw, 696 F.3d at 1135.
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In March 2006, Arbitrage sought judicial review of the FPAA pursuant to
§ 6226(a). In October 2014, the Court of Federal Claims issued an amended
judgment sustaining all adjustments of partnership items contained in the FPAA
and stating that the explanations offered in the FPAA are “conceded to be correct.”
It sustained all penalties contained in the FPAA but noted that “partners of
Arbitrage, LLC reserve their right to pursue partner-level defenses to these
penalties.” This concluded the partnership-level proceedings involving Arbitrage.
We next outline the partner-level proceedings initiated by Highpoint as well as
other interactions between the parties during that timeframe.
3. Partner-level proceedings
In November 2015, the IRS issued a Notice of Deficiency to Highpoint.
This notice reflected a deficiency of $5,222,675, based upon the following
adjustments: (1) a $13,191,937 increase in capital gains income representing the
disallowed short-term capital loss for the sale of the Euro option distributed from
Arbitrage when Highpoint left the partnership, (2) a disallowance of $1,573,727 in
claimed professional fee deductions relating to these transactions, and (3) an
increase of $72,053 in “other income” representing a disallowed loss from the
partnership. The notice also reflected a 40% gross valuation-misstatement penalty
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pursuant to I.R.C. § 6662(h) amounting to $2,089,070. Highpoint filed a petition
in the Tax Court for redetermination of its deficiency in February 2016.3
A few days later, the IRS issued a Notice of Tax Due reflecting the same
amount contained in the Notice of Deficiency as well as $12,755,355.16 in interest,
resulting in a total of $20,067,100.16 due. In June 2016, the IRS notified
Highpoint that it intended to levy Highpoint’s property and apply the proceeds to
the $20,067,100.16 owed. A few days after that, Highpoint filed a Motion to
Restrain Collection in the United States Tax Court. In July 2016, the IRS objected
to Highpoint’s Motion to Restrain Collection. The IRS asserted that, while the Tax
Court had jurisdiction over adjustments relating to capital gains income and the
professional fee deductions, it did not have jurisdiction over the valuation-
misstatement penalty and the adjustment to “other income.” In September 2016,
the IRS moved to dismiss the portions of the case before the Tax Court relating to
the adjustment to other income and the valuation-misstatement penalty, asserting
that neither were subject to deficiency proceedings under I.R.C. § 6230(a).
On July 17, 2017, the Tax Court ordered further briefing on the adjustment
to other income issue and denied Highpoint’s Motion to Restrain Collection to the
3
Highpoint’s Notice of Appeal only seeks review of the Tax Court’s July 17, 2017 order
denying Highpoint’s Motion to Restrain to the extent that it related to the valuation-misstatement
penalty. Because Highpoint’s petition for redetermination of its deficiency is not at issue in this
appeal, we do not discuss it further.
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extent that it related to the penalty. As to the valuation-misstatement penalty, the
Tax Court stated:
In United States v. Woods, 134 S. Ct. 557, 565–566 (2013), the
Supreme Court stated that where the partnership is a sham, no partner-
level determinations are needed to determine outside basis because
“once the partnerships were deemed not to exist for tax purposes, no
partner could legitimately claim an outside basis greater than zero.”
See also Greenwald v. Commissioner, 142 T.C. 308, 315 (2014). It is
not possible for petitioner to have an outside basis greater than zero in
Arbitrage, a partnership that does not exist for tax purposes. The final
decision in the partnership-level proceeding applied the section 6662
penalty. It is well settled that the penalty may be directly assessed as a
computational adjustment that we lack jurisdiction over,
notwithstanding the need for partner-level determinations. See sec.
6230(a)(2), (c)(4); Woods, 571 S. Ct. at 565, n.2; Thompson v.
Commissioner, T.C. Memo. 2014–154 at *8; Logan Tr., 616 Fed.
Appx. 426 (D.C. Cir. 2015).
In August 2017, Highpoint filed a Motion for Reconsideration of the Tax
Court’s July 17 order. In support of its motion, Highpoint asserted that:
In the July 17 Order, the Court denied Petitioner’s Motion to Restrain
Assessment with respect to the gross valuation misstatement penalty.
To assert the gross valuation misstatement penalty, the Code requires
a comparison of the correct value versus the reported value of the
adjusted basis of the Euros that Highpoint sold in 1999. A
determination of the correct value, which Respondent admits must be
determined in a deficiency proceeding, cannot be completed without
the Court first completing partner-level factual determinations.
In November 2017, the Tax Court denied Highpoint’s Motion for Reconsideration
and granted the IRS’s motion to dismiss in full.4 As to the valuation-misstatement
4
The Tax Court held that it lacked jurisdiction not only over the valuation-misstatement
penalty but also over the “other income.” However, on appeal, Highpoint challenges the Tax
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penalty, the Tax Court determined that Highpoint had not established that
reconsideration should be granted and further noted that:
Deficiency proceedings do not apply to the assessment of
penalties determined to be applicable at the partnership level,
regardless of whether partner level determinations are required to
assess the penalty. I.R.C. sec. 6230(a)(2)(A)(i); sec. 301.6231(a)(6)-
1, Proced. & Admin. Regs. In the Amended Judgment relating to
prior partnership proceeding (Arbitrage Trading, LLC v. United
States, docket No. 06-202T), partnership items, including the
application of the penalty, were conclusively determined. See I.R.C.
secs. 6221 and 6320(c)(4). As such, this Court lacks jurisdiction over
the penalty, and we stand by our decision.
Highpoint now appeals the Tax Court’s July 17 order denying its Motion to
Restrain Collection to the extent that it found it had no jurisdiction over the gross
valuation-misstatement penalty.
II. ISSUE
The sole issue in this appeal is whether the Tax Court erred in denying
Highpoint’s Motion to Restrain Collection of the gross valuation-misstatement
penalty, and in holding that it lacked deficiency jurisdiction over the penalty.
III. STANDARD OF REVIEW
We review the Tax Court’s legal conclusions de novo, and its factual
findings for clear error. See Campbell v. Comm’r, 658 F.3d 1255, 1258 (11th Cir.
Court’s ruling only with respect to the valuation-misstatement penalty. Accordingly, this
opinion considers only the issue of whether the Tax Court had jurisdiction over the valuation-
misstatement penalty.
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2011). “[W]e review questions of subject matter jurisdiction and statutory
interpretation de novo.” Lindley v. F.D.I.C., 733 F.3d 1043, 1050 (11th Cir.
2013).
IV. DISCUSSION
Highpoint’s primary argument on appeal is that, because the valuation-
misstatement penalty is an “affected item[] which require[s] partner level
determinations,” it is necessarily subject to deficiency jurisdiction. Highpoint
contends that, because the penalty at issue is an “affected item[] which require[s]
partner level determinations,” it cannot also be a “penalt[y] . . . that relate[s] to
adjustments to partnership items.” See I.R.C. § 6230(a)(2)(A)(i). For the reasons
that follow, we conclude that the relevant statutory text, applicable regulations, and
Supreme Court precedent make clear that Highpoint’s arguments are without merit,
and that the Tax Court correctly held that it did not have deficiency jurisdiction
over the penalty. We begin our analysis by focusing on the statutory provision that
specifically addresses which partnership-related matters are subject to Tax Court
deficiency jurisdiction—and which are not. See I.R.C. § 6230(a).
A. Statutory Deficiency Jurisdiction
1. I.R.C. § 6230(a)(1)
Internal Revenue Code Chapter 63, subchapter B provides for Tax Court
deficiency proceedings. See I.R.C. §§ 6211–6216 (entitled “Deficiency
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Procedures in the Case of Income, Estate, Gift, and Certain Excise Taxes”). When
the IRS issues a notice of deficiency, notifying a taxpayer that the IRS has
determined that additional taxes are due, a taxpayer ordinarily has an option to pay
the additional taxes and file a claim for refund, or to challenge the IRS
determination without prepayment by filing a petition to the Tax Court seeking a
redetermination of the deficiency pursuant to the Tax Court’s deficiency
jurisdiction. See 13 Mertens Law of Federal Income Taxation § 49C:1 (2019)
(“Upon receipt of a notice of deficiency, a taxpayer may either file a petition with
the Tax Court to contest the amount of the deficiency or pay the amount of the
deficiency and sue for a refund in either the Claims Court or the appropriate
District Court.”). However, that general provision is modified by I.R.C. § 6230(a),
which specifically addresses the partnership-related issues before us and
specifically provides that some partnership-related matters are within the Tax
Court’s deficiency jurisdiction, and some are not. We begin with § 6230(a)(1),
which provides:
Except as provided in paragraph (2) or (3), subchapter B of this
chapter shall not apply to the assessment or collection of any
computational adjustment.
From § 6230(a)(1) alone we know that Tax Court deficiency proceedings (i.e.,
subchapter B) will not apply to—or in other words, the Tax Court will not have
deficiency jurisdiction over—assessment or collection of any computational
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adjustments other than those provided for in paragraphs two or three of
§ 6230(a)(1). We must therefore determine whether the penalty at issue is a
computational adjustment, and if so, whether it is otherwise provided for in
§ 6230(a)(2) or (a)(3).
We pause to define statutory terms necessary to understand § 6230(a)(1).
“Computational adjustment” is defined as “the change in the tax liability of a
partner which properly reflects the treatment under this subchapter of a partnership
item. All adjustments required to apply the results of a proceeding with respect to
a partnership under this subchapter to an indirect partner shall be treated as
computational adjustments.” I.R.C. § 6231(a)(6). In turn, a “partnership item” is
defined as “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 partnership level than at the partner level.”
§ 6231(a)(3).
Considering these definitions in conjunction with the text of § 6230(a)(1),
we know that if a change in tax liability of a partner reflects treatment of a
partnership item (an item required to be taken into account for the partnership’s
taxable year and more appropriately determined at the partnership level), then
deficiency proceedings will not apply to the assessment of that adjustment unless
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otherwise provided for in § 6230(a)(2) or (a)(3). Treasury regulations in effect at
the time in question state that “[a]ny penalty, addition to tax, or additional amount
that relates to an adjustment to a partnership item, shall be determined at the
partnership level.” Treas. Reg. § 301.6221-1T(c). The FPAA issued by the IRS to
Arbitrage stated that the valuation-misstatement penalty at issue relates to
adjustments to partnership items. It provided in pertinent part that “at a minimum,
the accuracy-related penalty under Section 6662(a) of the Internal Revenue Code
applies to all underpayments of tax attributable to adjustments of partnership items
of Arbitrage Trading, LLC.”
We agree with the IRS’s characterization of the penalty at issue as relating to
an adjustment to a partnership item. Treasury Regulation § 301.6231(a)(3)-1(b)
includes within its “partnership item” definition “the legal and factual
determinations that underlie the determination of the amount, timing, and
characterization of items of income, credit, gain, loss, deduction, etc.” Treas. Reg.
§ 301.6231(a)(3)-1(b) (emphasis added). The underlying legal determination that a
partnership is a sham lacking economic substance—which caused the penalty to be
applied in this case—falls within this “partnership item” definition. See id. (listing
as examples of such legal and factual determinations deemed “partnership items,”
among other things, “whether partnership activities have been engaged in with the
intent to make a profit”); accord RJT Invs. X v. Comm’r, 491 F.3d 732, 737–38
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(8th Cir. 2007) (holding that the determination that a partnership is a sham is a
“legal determination” that “falls squarely within” the definition of a partnership
item pursuant to Treas. Reg. § 301.6231(a)(3)-1(b)). Indeed, as demonstrated in
Part IV.B. below, the Supreme Court made clear in United States v. Woods that a
gross valuation-misstatement penalty—just like the one at issue in this case—
relates to a determination that the underlying partnerships are shams and, in turn,
relates to an adjustment to a partnership item. See Woods, 571 U.S. at 39–44, 134
S. Ct. at 563–66. For a more detailed discussion of Woods, see infra Part IV.B. 5
Accordingly, the penalty in question relates to an adjustment to a partnership item
and is therefore a computational adjustment not subject to deficiency jurisdiction
under § 6230(a)(1) unless otherwise provided for.
5
Many other courts have treated sham determinations, which can justify imposing a
valuation-misstatement penalty, as relating to adjustments to partnership items. See, e.g.,
Petaluma FX Partners, LLC v. Comm’r, 792 F.3d 72, 77 (D.C. Cir. 2015) (“[C]ourts retain
jurisdiction in partnership-level proceedings to determine whether any partnership-level
adjustments—such as the determination in this case that Petaluma was a sham—carry ‘the
potential to trigger a penalty’ against the partners.” (quoting Woods, 571 U.S. at 41, 134 S. Ct. at
565)); NPR Invs., L.L.C. ex rel. Roach v. United States, 740 F.3d 998, 1010 (5th Cir. 2014)
(holding that the partnership-level court had jurisdiction to adjudicate the applicability of the
valuation-misstatement penalties where the partnership was a sham, and stating that “we
conclude that the District Court had jurisdiction to determine the applicability of the valuation-
misstatement penalty—to determine, that is, whether the partnerships’ lack of economic
substance (which all agree was properly decided at the partnership level) could justify imposing
a valuation-misstatement penalty on the partners.” (quoting Woods, 571 U.S. at 42, 137 S. Ct. at
564)); RJT Invs., 491 F.3d at 737–38 (holding that a determination that a partnership is a sham is
a partnership item).
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The plain text of § 6230(a)(1), when read in conjunction with definitional
statutory provisions and applicable regulations, makes clear that unless otherwise
provided in § 6230(a)(2) or (a)(3), the Tax Court does not have deficiency
jurisdiction over the penalty at issue. Highpoint argues that § 6230(a)(2)(A)(i)
nonetheless provides the Tax Court deficiency jurisdiction over the penalty
because the penalty is an “affected item[] which require[s] partner level
determinations.” We address that argument next. 6
2. I.R.C. § 6230(a)(2)(A)(i)
Section 6230(a)(2)(A) provides that:
Subchapter B shall apply to any deficiency attributable to affected
items which require partner level determinations (other than penalties,
additions to tax, and additional amounts that relate to adjustments to
partnership items) . . . .
I.R.C. § 6230(a)(2)(A)(i). From the face of § 6230(a)(2)(A)(i), we know that, even
with respect to affected items requiring partner-level determinations, Tax Court
deficiency proceedings will not apply to—or in other words, will not have
jurisdiction over—“penalties . . . that relate to adjustments to partnership items.”
Highpoint’s argument focuses on the penalty being an “affected item[] which
require[s] partner level determinations,” but this argument ignores the exclusion
within the same sentence. The parenthetical exclusion makes clear that, even if the
6
Highpoint does not argue that other provisions of § 6230(a)(2) or (a)(3) provide the Tax
Court with deficiency jurisdiction over the penalty.
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deficiency at issue is attributable to an affected item which requires partner-level
determinations, deficiency proceedings will not apply to “penalties . . . relat[ing] to
adjustments to partnership items.” § 6230(a)(2)(A)(i). The issue, again, is whether
the penalty at issue “relates to [an] adjustment[] to [a] partnership item.”
“Affected item” is defined as “any item to the extent such item is affected by
a partnership item,” § 6231(a)(5), while “partnership item” is defined as “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
partnership level than at the partner level,” § 6231(a)(3). As outlined above, Treas.
Reg. § 301.6231(a)(3)-1(b) and the Supreme Court’s decision in Woods make clear
that the penalty in question relates to an adjustment to a partnership item.
Accordingly, the penalty is not subject to Tax Court deficiency jurisdiction under
§ 6230(a)(2)(A)(i). 7
7
The Tax Court has frequently held that penalties deemed to apply in partnership-level
proceedings are not subject to Tax Court deficiency jurisdiction under § 6230(a)(2)(A)(i). See,
e.g., Domulewicz v. Comm’r, 129 T.C. 11, 21–23 (2007) (“Under a plain reading of
[§ 6230(a)(2)(A)(i)], the effect of the amendment was to remove partnership-item penalties from
the deficiency procedures effective for partnership taxable years ending after August 5, 1997.”),
aff’d in part remanded in part on other grounds Desmet v. Comm’r, 581 F.3d 297 (6th Cir.
2009); Fears v. Comm’r, 129 T.C. 8, 10 (2007); Estate of Simon v. Comm’r, T.C. Memo. 2013-
174, 2013 WL 3879804, at *4 (2013); Bedrosian v. Comm’r, T.C. Memo. 2007-376, 2007 WL
4526479, at *3 (2007).
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In addition to contradicting the plain language of § 6230(a)(2)(A)(i),
Highpoint’s argument that the penalty is subject to Tax Court deficiency
jurisdiction because it is an “affected item[] which require[s] partner level
determinations” is undermined by Treasury Regulations in effect during the time in
question.
Changes in a partner’s tax liability with respect to affected items that
require partner level determinations . . . are computational adjustments
subject to deficiency procedures. Nevertheless, 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 determinations are required.
Treas. Reg. § 301.6231(a)(6)-1T(a)(2). This only confirms what is unambiguous
from the plain meaning of § 6230(a)(1) and (a)(2)(A)(i)—namely, that penalties
relating to adjustments to partnership items are treated differently (i.e., not subject
to Tax Court deficiency jurisdiction) even if they are affected items requiring
partner level determinations. See also Woods, 571 U.S. at 41, 134 S. Ct. at 564(holding that “a penalty can relate to a partnership-item adjustment even if the
penalty cannot be imposed without additional, partner-level determinations”).
Highpoint argues that preventing it from addressing the penalty in Tax Court
deficiency proceedings—and forcing it to raise challenges to the penalty in refund
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or Collection Due Process (“CDP”) proceedings instead 8—is duplicative and
contrary to the congressional intent behind the 1997 amendments to TEFRA that
sought to streamline partnership tax litigation. “We have . . . said . . . frequently
that ‘[w]hen the import of words Congress has used is clear . . . we need not resort
to legislative history, and we certainly should not do so to undermine the plain
meaning of the statutory language.’” CBS Inc. v. PrimeTime 24 Joint Venture,
245 F.3d 1217, 1222 (11th Cir. 2001) (quoting Harris v. Garner, 216 F.3d 970, 976
(11th Cir. 2000) (en banc)). Because we find that § 6230(a)(1) and (a)(2)(A)(i)
8
Even though Highpoint may not challenge the penalty in the instant partner-level Tax
Court deficiency proceedings, it still has the opportunity to raise partner-level defenses regarding
the penalty (including the good faith and reasonable cause defenses it alludes to throughout its
brief) in refund proceedings. See § 6230(c)(4) (“[T]he partner shall be allowed to assert any
partner level defenses that may apply or to challenge the amount of the computational
adjustment.”). Highpoint argues that it would be unfair not to provide Tax Court deficiency
jurisdiction over the penalty because that would require Highpoint, and similarly situated
taxpayers, to pay large sums of tax liability before challenging the penalty in refund proceedings.
“[E]ven if we agree that the statute allows for harsh or unfair consequences, that does not give us
license to ignore the plain meaning of the text. We will look beyond the
unambiguous plain meaning of the text only if the plain meaning produces absurd results.” Patel
v. U.S. Attorney Gen., 917 F.3d 1319, 1330 (11th Cir. 2019). We will not ignore the plain
meaning of I.R.C. § 6230 in this case.
Moreover, there is an opportunity for Highpoint to challenge the penalty other than
through refund proceedings and prior to payment—i.e., in a prepayment proceeding other than
refund proceedings. Highpoint can challenge the penalty in a prepayment Collection Due
Process (“CDP”) hearing as provided for by § 6330(a)(1), which states “[n]o levy may be made
on any property or right to property of any person unless the Secretary has notified such person
in writing of their right to a hearing under this section before such levy is made.” At this
hearing, Highpoint may raise “challenges to the underlying tax liability for any tax period if the
person . . . did not otherwise have an opportunity to dispute such tax liability.” § 6330(c)(2)(B).
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clearly exclude the penalty at issue from Tax Court deficiency jurisdiction, we
need not entertain Highpoint’s legislative intent arguments. 9
We conclude that the Internal Revenue Code unambiguously excludes from
the Tax Court’s deficiency jurisdiction Highpoint’s challenge to the penalty at
issue. Nevertheless, Highpoint relies on United States v. Woods to argue that the
Tax Court has jurisdiction over the penalty. Quite contrary to Highpoint’s
argument, however, Woods only provides further and significant support for what
9
Highpoint also argues that “imposing the 40 percent basis penalty before determining
the basis or the resulting deficiency works an algebraic absurdity” because it is impossible to
calculate the penalty without first determining the basis and deficiency in partner-level
deficiency proceedings. We are not convinced that holding that there is no Tax Court deficiency
jurisdiction over the penalty produces such absurd results as to justify ignoring the unambiguous
plain meaning of § 6230. See Patel, 917 F.3d at 1330. The Supreme Court in Woods noted that
the district court presiding over partnership-level proceedings “was not required to shut its eyes
to the legal impossibility of any partner’s possessing an outside basis greater than zero in a
partnership that, for tax purposes, did not exist.” Woods, 571 U.S. at 42, 134 S. Ct. at 565. The
Woods Court also noted in dicta that “it is not readily apparent why additional partner-level
determinations would be required before adjusting outside basis in a sham partnership.” Id. at 42
n.2, 134 S. Ct. at 565 n.2 (citing Petaluma, 591 F.3d at 655 (“If disregarding a partnership leads
ineluctably to the conclusion that its partners have no outside basis, that should be just as
obvious in partner-level proceedings as it is in partnership-level proceedings”)).
We acknowledge the problem to which Highpoint points. The applicability of the 40%
penalty has been determined during partnership-level proceedings. However, that 40% penalty is
to be applied to the appropriate portion of the deficiency which Highpoint is ultimately
determined to owe. That deficiency amount would ordinarily be determined in Tax Court
deficiency proceedings. It might well have been preferable, in an ideal world, had Congress
permitted the precise amount of the penalty to be determined also in the same deficiency
proceedings. However, Congress clearly did not permit that. But, there are at least two other
partner-level proceedings available in which the appropriate deficiency and precise amount of
the penalty can be determined—CDP proceedings or refund proceedings. In any event, the
problem about which Highpoint complains falls far short of the kind of absurdity that might
warrant assuming that Congress intended the opposite of which it plainly stated.
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the Internal Revenue Code makes unambiguous—that the Tax Court does not have
deficiency jurisdiction over the penalty.
B. United States v. Woods
The Supreme Court, in United States v. Woods, addressed a related but
distinct question of whether “the penalty for tax underpayments attributable to
valuation misstatements, 26 U.S.C. § 6662(b)(3), is applicable to an underpayment
resulting from a basis-inflating transaction subsequently disregarded for lack of
economic substance.” Woods, 571 U.S. at 33, 134 S. Ct. at 560. Woods arose
from partnership-level proceedings considering an appeal of an FPAA. Id. at 37,
134 S. Ct. at 562. The respondent taxpayer in Woods participated in a Current
Options Bring Reward Alternatives (“COBRA”) tax shelter. Id. at 34, 134 S. Ct. at
560. This tax shelter used offsetting options to give respondent taxpayer an
artificially high basis in partnership interests so that he could claim significant
losses on paper, thereby reducing taxable income. Id. at 33–35, 134 S. Ct. at 560–
61. The IRS did not treat these COBRA-generated losses as valid and issued an
FPAA stating that the partnerships lacked economic substance, the partnerships
would be disregarded for tax purposes, and the losses would be disallowed. Id. at
36–37, 134 S. Ct. at 561–62. Having determined that there was no partnership for
tax purposes, the IRS also concluded that the partners had “not established adjusted
bases in their respective partnership interests in an amount greater than zero” and
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that any underpayment of tax would be subject to the 40% gross valuation-
misstatement penalty—the exact same penalty at issue in this case. Id. at 37, 134
S. Ct. at 562.
Pursuant to § 6226(a)(2), respondent (the tax matters partner for the
partnerships) appealed the FPAA’s determination that the 40% penalty was
applicable when the underlying transaction is disregarded for lack of economic
substance. Id. Both the district court and the court of appeals held that, although
the partnerships were shams, the valuation-misstatement penalty did not apply. Id.
The Supreme Court, in addition to considering this question, also ordered briefing
on whether the district court presiding over the partnership-level proceedings had
“jurisdiction to consider the valuation-misstatement penalty.” Id. at 37–38, 134 S.
Ct. at 562. The jurisdictional question before the Court in Woods is distinct from
the one currently before us because it considered whether the district court had
partnership-level jurisdiction over a valuation-misstatement penalty, whereas we
are asked to determine whether the Tax Court had partner-level deficiency
jurisdiction over a valuation-misstatement penalty. Despite the different
procedural postures, Woods’s discussion of the same penalty at issue in this case is
instructive.
Under TEFRA, a court presiding over a partnership-level proceeding has
jurisdiction to determine both partnership items and “the applicability of any
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penalty . . . which relates to an adjustment to a partnership item.” § 6226(f). We
take note that the phrase “penalty . . . which relates to an adjustment to a
partnership item” that appears in § 6226(f) is nearly identical to the phrase
“penalties . . . that relate to adjustments to partnership items” in § 6230(a)(2)(A)(i),
which is at issue in this case. The Woods Court framed the jurisdictional issue
before it as follows:
As both sides agree, a determination that a partnership lacks
economic substance is an adjustment to a partnership item. Thus, the
jurisdictional question here boils down to whether the valuation-
misstatement penalty “relates to” the determination that the
partnerships Woods and McCombs created were shams.
Woods, 571 U.S. at 39, 134 S. Ct. at 563. The Government argued that the
valuation-misstatement penalty “logically and inevitably” flowed from the
economic-substance (or sham) determination. See id. at 39–40, 134 S. Ct. at 563.
Because there can be no outside basis in a sham partnership, the Government
contended, any partner who reports an outside basis greater than zero commits a
valuation misstatement. See id. The respondent taxpayer argued that, because
outside basis is an affected item and not a partnership item, a penalty resting on a
misstatement of an outside basis could not be considered at the partnership level.
See id. at 40, 134 S. Ct. at 563. The Court summarized his argument as follows:
“He maintains, in short, that a penalty does not relate to a partnership-item
adjustment if it ‘requires a partner-level determination,’ regardless of ‘whether or
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not the penalty has a connection to a partnership item.’” Id. This argument made
by the taxpayer in Woods is nearly identical to the one Highpoint advances before
this Court—i.e., that because the penalty at issue is an affected item requiring
partner-level determinations, it cannot also relate to adjustments to partnership
items.
The Court rejected the taxpayer’s arguments, and held that
TEFRA gives courts in partnership-level proceedings jurisdiction to
determine the applicability of any penalty that could result from an
adjustment to a partnership item, even if imposing the penalty would
also require determining affected or non-partnership items such as
outside basis.
Id. at 41, 134 S. Ct. at 564. The Court explained that even though every penalty
must be imposed after partner-level determinations are made at the partner level,
“TEFRA provides that the applicability of some penalties must be determined at
the partnership level. The applicability determination is therefore inherently
provisional; it is always contingent upon determinations that the court in a
partnership-level proceeding does not have jurisdiction to make.” 10 Id. at 41, 134
10
Highpoint focuses on this passage from Woods in arguing that imposing the penalty is
merely provisional at the partnership stage and that the penalty can actually be imposed only
after determining the outside basis and deficiency in partner-level proceedings. By stating that
the partnership-level determination that a penalty is “provisional,” however, the Woods Court
was indicating that the district court did not have jurisdiction to consider partner-level defenses
in a partnership-level proceeding. The Court did not state that the “provisional” nature of this
penalty at the partnership level indicated that partner-level Tax Court deficiency proceedings
would have jurisdiction. In other words, the Court’s suggestion that the penalty would have to
be actually imposed in partner-level proceedings did not indicate that the appropriate partner-
level forum would be Tax Court deficiency proceedings. There are at least two other partner-
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S. Ct. at 564. The Court in Woods explained that several provisions of TEFRA
make clear that courts presiding over partnership-level proceedings have
jurisdiction to consider the applicability of some penalties that cannot be imposed
without partner-level inquiries. Id.
One requires the IRS to use deficiency proceedings for computational
adjustments that rest on “affected items which require partner level
determinations (other than penalties . . . that relate to adjustments to
partnership items).” § 6230(a)(2)(A)(i). Another states that while a
partnership-level determination “concerning the applicability of any
penalty . . . which relates to an adjustment to a partnership item” is
“conclusive” in a subsequent refund action, that does not prevent the
partner from “assert[ing] any partner level defenses that may apply.”
§ 6230(c)(4). Both these provisions assume that a penalty can relate
to a partnership-item adjustment even if the penalty cannot be
imposed without additional, partner-level determinations.
Id. In other words, the Court made clear that penalties relating to partnership-item
adjustments and penalties that cannot be actually imposed without additional,
partner-level determinations are not mutually exclusive. See id.
In sum, the Court in Woods rejected the argument of the taxpayer Woods—
i.e., “that a penalty does not relate to a partnership-item adjustment if it requires a
partner-level determination.” Id. at 40, 134 S. Ct. at 563 (internal quotation marks
omitted). The Court held that the gross valuation-misstatement penalty at issue
level proceedings—refund proceedings and CDP proceedings. Indeed, previously in the opinion,
the Woods Court indicated that “[m]ost computational adjustments may be directly assessed
against the partners, bypassing deficiency proceedings and permitting the partners to challenge
the assessments only in post-payment refund actions.” Woods, 571 U.S. at 39, 134 S. Ct. at 563
(citing § 6230(a)(1), (c)).
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there related to the determination that the partnerships were a sham, which
determination was an adjustment to a partnership item. Id. at 39–42, 134 S. Ct. at563–64. Thus, the Court held that, under § 6226(f), the partnership-level court at
issue there had jurisdiction over the gross valuation-misstatement penalty because
the penalty related to an adjustment to a partnership item. Id. The Court’s
reasoning proceeded as follows. The Court first set out the issue before it:
Under the TEFRA framework, a court in a partnership-level
proceeding like this one has jurisdiction to determine not just
partnership items, but also “the applicability of any penalty . . . which
relates to an adjustment to a partnership item.” § 6226(f). As both
sides agree, a determination that a partnership lacks economic
substance is an adjustment to a partnership item. Thus, the
jurisdictional question here boils down to whether the valuation-
misstatement penalty “relates to” the determination that the
partnerships . . . created were shams.
Id. at 39, 134 S. Ct. at 563. The Court then set out the Government’s position:
In the Government’s view, there can be no outside basis in a sham
partnership . . . , so any partner who underpaid his individual taxes by
declaring an outside basis greater than zero committed a valuation
misstatement. In other words, the penalty flows logically and
inevitably from the economic-substance determination.
Id. at 39–40, 134 S. Ct. at 563. The Court next set out the argument of taxpayer
Woods:
He maintains, in short, that a penalty does not relate to a partnership-
item adjustment if it requires a partner-level determination, regardless
of whether or not the penalty has a connection to a partnership item.
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Id. at 40, 134 S. Ct. at 563 (internal quotation marks omitted). The Court then
noted that several provisions in the Internal Revenue Code, including
§ 6230(a)(2)(A)(i) and § 6230(c)(4), indicate that:
A penalty can relate to a partnership-item adjustment even if the
penalty cannot be imposed without additional partner-level
determinations.
Id. at 41, 134 S. Ct. at 564. The Court then rejected the argument of taxpayer
Woods, and held:
that TEFRA gives courts in partnership-level proceedings jurisdiction
to determine the applicability of any penalty that could result from an
adjustment to a partnership item, even if imposing the penalty would
also require determining affected or non-partnership items such as
outside basis. . . .
Applying the foregoing principles to this case, we conclude that
the District Court had jurisdiction to determine the applicability of the
valuation-misstatement penalty—to determine, that is, whether the
partnerships’ lack of economic substance (which all agree was
properly decided at the partnership level) could justify imposing a
valuation-misstatement penalty on the partners.
Id. at 41–42, 134 S. Ct. at 564.
Woods strongly supports what we already determined to be unambiguous
from the relevant Internal Revenue Code provisions. The valuation-misstatement
penalty at issue can be an affected item requiring partner-level determinations
while also relating to adjustments to partnership items. Woods directly rejects
Highpoint’s argument that these categories are mutually exclusive. Woods leaves
no doubt that the valuation-misstatement penalty at issue is related to an
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adjustment to a partnership item so as to clearly fall within § 6230(a)(2)(A)(i)’s
exclusion of such items from deficiency jurisdiction.
V. CONCLUSION
For the foregoing reasons, we conclude that the relevant statutory
provisions, applicable regulations, and precedent—including in particular the
Supreme Court decision in Woods—indicate clearly that the valuation-
misstatement penalty at issue, which was triggered by the partnership-level
determination that Arbitrage lacked economic substance, relates to an adjustment
to a partnership item, and thus is excluded from the Tax Court’s deficiency
jurisdiction under § 6230(a)(2)(A)(i). We hold that the Tax Court presiding over
partner-level deficiency proceedings did not have jurisdiction over the valuation-
misstatement penalty at issue.11 The Tax Court’s order denying Highpoint’s
Motion to Restrain Collection to the extent it related to the valuation-misstatement
penalty is therefore
AFFIRMED.
11
Other arguments raised by Highpoint on appeal need not be addressed in light of our
jurisdictional holding.
29