Raghunathan Sarma & Gaile Sarma v. Commissioner

T.C. Memo. 2018-201UNITED STATES TAX COURT
RAGHUNATHAN SARMA AND GAILE SARMA, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 26318-16. Filed December 12, 2018.
Charles E. Hodges II, Antoinette G. Ellison, and Aditya Shrivastava, for
petitioners.
Leslie J. Spiegel and Craig Connell, for respondent.
MEMORANDUM OPINION
GOEKE, Judge: This case is before us on the parties’ cross-motions to
dismiss for lack of jurisdiction following respondent’s issuance of an affected item
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[*2] notice of deficiency. The parties submitted a declaration of witnesses with
attached exhibits.1
Background
When the petition was filed, petitioner Raghunathan Sarma resided in
Florida. Petitioner Gaile Sarma had a mailing address in New Jersey; the record
does not provide her State of residence. During the years at issue petitioners were
married and filed joint tax returns. They divorced in 2005.
The adjustments in the notice of deficiency arise from Raghunathan Sarma’s
participation in a tax shelter known as a “Family Office Customized partnership”
or “FOCus”, a transaction substantially similar to the transaction described in
Notice 2002-50, 2002-2 C.B. 98. Mr. Sarma implemented the FOCus tax shelter
through a series of transactions executed by a three-tiered set of limited liability
companies treated as partnerships for Federal tax purposes:2 the upper tier
partnership, Nebraska Partners Fund, LLC (Nebraska Partners or Nebraska), the
middle-tier partnership, Lincoln Partners Fund, LLC (Lincoln Partners or
1
Respondent disputes that the declaration and exhibits submitted by
petitioners allow us to grant petitioners’ motion to dismiss. We will deny
petitioners’ motion and do not need to address the factual disputes. In response to
respondent’s motion, petitioners state that the material facts are not in dispute.
2
For simplicity, we refer to the entities as partnerships.
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[*3] Lincoln), and the lower tier partnership, Kearney Partners Fund, LLC
(Kearney Partners or Kearney). The tax shelter resulted in a series of deemed
terminations of the partnerships and deemed formations of new partnerships
because of changes in the ownership of the partnerships, including Mr. Sarma’s
purchases of Lincoln Partners and Nebraska Partners. Because of the deemed
terminations, the partnerships filed tax returns for multiple short tax periods
during 2001. Lincoln and Kearney were subject to the unified partnership audit
and litigation procedures (TEFRA) under sections 6221 through 6234 for short tax
periods (TEFRA tax periods) when Mr. Sarma did not formally own direct
interests in the partnerships.3 He was an indirect partner in both partnerships
during certain TEFRA tax periods. Of significance, Lincoln Partners was not
subject to TEFRA for the short tax period that Mr. Sarma held a direct interest in it
because it fell within the small partnership exception to TEFRA under section
6231(a)(1)(B) (small partnership tax period) and did not elect to be subject to
TEFRA.
3
Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the years at issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure. All amounts are rounded to the
nearest dollar.
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[*4] The issues for consideration are: (1) whether respondent is bound by an
initial decision (later abandoned) to audit Lincoln Partners’ return for the small
partnership tax period under the TEFRA procedures; we hold he is not;
(2) whether the special statute of limitations rules for TEFRA partnerships under
section 6229 apply for petitioners’ 2001 tax year; we hold they do; (3) whether a
partner-level determination is required to adjust petitioners’ tax liabilities
following the decision in the TEFRA case; we hold it is; and (4) whether
respondent issued invalid multiple notices of deficiency; we hold he did not.
I. Tax Shelter Transactions
Nebraska Partners and Lincoln Partners were formed on October 17, 2001.
The date of Kearney Partners’ organization is not stated in the record. As of
December 4, 2001, as part of the structure of the FOCus tax shelter, Nebraska
Partners owned 99% of Lincoln Partners, and Lincoln Partners owned 99% of
Kearney Partners. Bricolage Capital Management Co., a C corporation, was a 1%
partner in Nebraska and Lincoln and the tax matters partner of each. Delta
Currency Management Co. was a 1% partner and the tax matters partner of
Kearney Partners. Each of the three partnerships filed a partnership tax return for
the short tax period of October 17 to November 20, 2001 (November 20, 2001, tax
period), before Mr. Sarma acquired an ownership interest in the partnerships.
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[*5] The tax shelter involved three transactions relating to ownership changes of
the partnerships within the tiered structure. On December 4, 2001, Mr. Sarma
purchased a 99% interest in Nebraska Partners. All three partnerships terminated
their tax periods on December 4, 2001, pursuant to section 708(b)(1)(B), for short
tax periods of November 21 to December 4, 2001 (December 4, 2001, tax period).
See sec. 1.708-1(b)(2), Income Tax Regs. (providing that a partnership and any
lower tier partnerships shall terminate when 50% or more of the total interest in
the partnership’s capital and profits is sold or exchanged within a 12-month
period). New partnerships were deemed to be formed for the three partnerships,
and the partnerships treated their new tax periods as beginning on December 5,
2001.4 See id. para. (b)(4) (providing that when a partnership is deemed to
terminate by a sale or exchange of an interest, the partnership is deemed to
contribute its assets and liabilities to a new partnership in exchange for an interest
in the new partnership, and the terminated partnership is deemed to distribute
interests in the new partnership to the purchasing partner and other remaining
partners in liquidation of the terminated partnership). Each of the three
4
Respondent did not contest the December 5, 2001, date used for the
beginning of the partnerships’ tax periods.
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[*6] partnerships filed a partnership tax return for the December 4, 2001, tax
period on the basis of its deemed termination.
On December 14, 2001, Mr. Sarma purchased a 99% interest in Lincoln
Partners from Nebraska Partners; Mr. Sarma already indirectly owned Lincoln
Partners through Nebraska Partners. Mr. Sarma directly held the partnership
interest in Lincoln Partners for the remainder of 2001. On December 14, 2001,
Lincoln and Kearney terminated their tax periods pursuant to section 708(b)(1)(B)
on the basis of Mr. Sarma’s purchase of Lincoln Partners, and two new
partnerships were deemed to be organized. See sec. 1.708-1(b)(4), Income Tax
Regs. Both Lincoln and Kearney reported short tax periods of December 5 to 14,
2001 (December 14, 2001, tax period). On December 19, 2001, Lincoln Partners,
with Mr. Sarma as a 99% partner, sold its 99% interest in Kearney Partners for
$737,118 to Fermium II Partners Fund, LLC, an entity related to the tax shelter
promoter. As a result of the sale, Kearney Partners terminated its tax period,
reporting a short tax period of December 15 to 19, 2001 (December 19, 2001, tax
period). Lincoln Partners filed a partnership return for the short tax period of
December 15 to 31, 2001 (December 31, 2001, tax period), and continued to file
returns for 2002 through 2004 with Mr. Sarma as its partner.
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[*7] Beginning before December 4, 2001, the date Mr. Sarma purchased his
Nebraska partnership interest, through December 19, 2001, the date Lincoln sold
its Kearney Partners interest, Kearney Partners executed offsetting foreign
currency options (FX straddles) generating significant artificial gains and losses.
At the time of Lincoln’s sale of its Kearney partnership interest, Kearney Partners
held $737,118 in cash and certificates of deposit totaling $81,794,837.5 It had
unrealized losses from the FX straddles that had not been closed out, but it also
had realized gain from the FX straddles. Lincoln Partners claimed that it had an
outside basis in its Kearney partnership interest at the time of the sale of
$79,110,062 on the basis of the gain from the FX straddles. It did not account for
the unrealized losses, however. Lincoln Partners reported a short-term capital loss
of $78,392,194 on the sale of its Kearney partnership interest (Lincoln loss) for its
December 31, 2001, tax period. It allocated $77,608,272 of the Lincoln loss to
Mr. Sarma as its 99% partner (Sarma loss). Petitioners claimed a deduction for the
Sarma loss on their 2001 joint tax return and carried forward portions of the loss to
2002 through 2004.
5
Kearney Partners retained the certificates of deposit and cash when
Lincoln sold its Kearney partnership interest. Mr. Sarma did not receive any
distributions from Kearney Partners upon Lincoln’s sale of the Kearney
partnership interest.
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[*8] On the basis of the above transactions, Lincoln Partners filed partnership tax
returns for the following three short tax periods during which Mr. Sarma owned an
indirect or direct interest: (1) the December 4, 2001, tax period, (2) the December
14, 2001, tax period, and (3) the December 31, 2001, tax period. Lincoln Partners
was subject to TEFRA for the first two tax periods, December 4 and 14, 2001. For
a portion of Lincoln’s December 31, 2001, tax period, from December 15 to 19,
2001, Lincoln was a 99% partner of Kearney, and Kearney was subject to TEFRA
during that time. Lincoln was a small partnership exempt from TEFRA for its
December 31, 2001, tax period, the only tax period that Mr. Sarma was a direct
partner. Lincoln Partners’ return for its December 31, 2001, tax period (December
31, 2001, return) shows that it had two partners and neither partner was the type
that would cause TEFRA to automatically apply. Lincoln did not attach a
statement to its December 31, 2001, tax return electing to opt out of the small
partnership exception and to apply TEFRA. See sec. 301.6231(a)(1)-1(b)(2),
Proced. & Admin. Regs. (a small partnership may elect to apply TEFRA by filing
an attachment to its return). On its December 31, 2001 tax return, Lincoln
Partners answered “yes” on line 4 of Schedule B to the question of whether it was
subject to TEFRA and named a tax matters partner.
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[*9] During Lincoln’s December 31, 2001 tax period, Mr. Sarma contributed
$36.5 million in cash to Lincoln Partners. The record does not establish whether
the contribution occurred before or after Lincoln sold its interest in Kearney
Partners. However, Mr. Sarma’s outside basis in Lincoln is not at issue here. Mr.
Sarma also guaranteed a $38.8 million loan used to execute the FX straddles. The
lender did not require the guaranty from Mr. Sarma as the FX straddles did not
result in any risk to the lender. Kearney Partners Fund, LLC ex rel. Lincoln
Partners Fund v. United States (Kearney), No. 2:10-cv-153-FtM-37CM, 2014 WL
905459, at *9 (M.D. Fla. Mar. 7, 2014), aff’d per curiam, 803 F.3d 1280 (11th Cir.
2015).
II. Procedural History
In May 2003 the Internal Revenue Service (IRS) began an examination of
petitioners’ 2001 return. Revenue Agent Barbara Rickard issued notices of
beginning of administrative proceeding (NBAP) dated June 6, 2003, to the three
partnerships for the following 10 tax periods:
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[*10] Partnership Tax period
Nebraska Partners Nov. 20, 2001
Dec. 4, 2001
Lincoln Partners Nov. 20, 2001
Dec. 4, 2001
Dec. 14, 2001
Kearney Partners Nov. 20, 2001
Dec. 4, 2001
Dec. 14, 2001
Dec. 19, 2001
Dec. 31, 2001
Subsequently, Revenue Agent Rickard issued NBAPs dated April 6 and
March 10, 2004, for Nebraska Partners’ and Lincoln Partners’ December 31, 2001,
tax periods, respectively. Respondent did not issue the NBAPs to Mr. Sarma. Mr.
Sarma was not a notice partner to whom respondent was required to issue an
NBAP. See sec. 6223(a) (requiring the Commissioner to issue notice partners
notices of the beginning and end of a partnership audit). In mid-2004 the
examination for the partnerships was transferred to Revenue Agent Linda Scheick.
In late 2004 she determined that neither Lincoln Partners nor Nebraska Partners
was subject to TEFRA for its December 31, 2001, tax period because both fell
within the small partnership exception and accordingly the NBAPs were issued in
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[*11] error. She did not solicit a written extension of the period of limitations for
Nebraska’s or Lincoln’s December 31, 2001, tax period.
On July 31, 2009, respondent issued a notice of deficiency to petitioners for
2001 through 2004 (2009 notice), adjusting partnership and/or affected items of
the three partnerships relating to the partnerships’ November 20, 2001, tax periods
and items unrelated to any of the three partnerships. Respondent determined that
the three partnerships were shams and raised economic substance, step transaction,
substance over form, and other issues relating to the FOCus tax shelter. The
notice stated that it was for protective purposes in the event that the adjustments
were not subject to partnership-level proceedings under TEFRA. Petitioners filed
a petition with this Court and a motion to dismiss for lack of jurisdiction as to the
partnership and affected items on the basis that the partnerships were subject to
TEFRA. Respondent did not object to the motion but filed a response explaining
his position that the Court lacked jurisdiction over the partnership and affected
items. He asserted that both Lincoln Partners and Nebraska Partners were small
partnerships exempt from TEFRA for their December 31, 2001, tax periods.
Respondent’s Response to Petitioner’s Motion to Dismiss, Sarma v. Commissioner
(Sarma I), T.C. Dkt. No. 25694-09 (Nov. 16, 2012). Respondent identified the
Sarma loss as an affected item and asserted that Lincoln’s outside basis in its
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[*12] Kearney partnership interest is an affected item determined with reference to
the three partnerships’ TEFRA tax periods. The Court dismissed the partnership
and affected items on the basis of lack of jurisdiction in an order dated November
1, 2010. The parties settled the remaining adjustments. The November 16, 2012,
decision document included the following stipulation:
Mr. Sarma does not concede that he has an interest in the outcome
under I.R.C. § 6226(d) of any partnership proceedings involving
Kearney, Lincoln, and Nebraska * * * or that any adjustment made to
partnership items impacts the tax liabilities of Petitioners for tax years
2001, 2002, 2003, and/or 2004.
On December 9, 2009, respondent issued nine notices of final partnership
administrative adjustment (FPAAs) to Nebraska Partners, Lincoln Partners, and
Kearney Partners for their TEFRA tax periods for which the IRS had issued
NBAPs, see supra pp. 9-10, except that he did not issue FPAAs for Nebraska’s and
Lincoln’s small partnership tax periods, the December 31, 2001, tax periods. In
the FPAAs respondent determined that the three partnerships were disregarded for
tax purposes and reallocated their income, loss, and expenses to Mr. Sarma,
including those for their November 20, 2001, and December 4, 2001, tax periods
when Mr. Sarma was neither a direct nor indirect partner. He disallowed the
Lincoln loss on the basis that the partnerships were abusive tax shelters designed
to generate artificial tax losses. Mr. Sarma did not directly own any interest in the
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[*13] partnerships for the TEFRA tax periods. However, he did own indirect
interests for certain TEFRA tax periods.
Respondent included a letter with the FPAAs mailed to Mr. Sarma stating
that he had the right to elect to have his partnership items treated as
nonpartnership items and thereby opt out of TEFRA under section 6223(e)
because of the IRS’ failure to timely issue NBAPs to him. See sec. 6223(d)
(requiring the Commissioner to issue an NBAP at least 120 days before issuing an
FPAA) and (e) (providing the right to opt out of TEFRA for notice partners who
did not timely receive an NBAP). On January 23, 2010, Mr. Sarma filed an
election with the IRS opting out of TEFRA. Respondent in a letter dated February
25, 2010, stated that he had erred and Mr. Sarma did not have the right to opt out
of TEFRA because he did not have the right to receive an NBAP. On December 3,
2010, respondent issued a protective converted items notice of deficiency to
petitioners for 2001 through 2004 (2010 notice) because of Mr. Sarma’s attempted
election to opt out of TEFRA. The 2010 notice contained the same adjustments to
partnership and affected items as the 2009 notice but did not contain the
adjustments unrelated to the three partnerships. Respondent filed a motion to
dismiss for lack of jurisdiction, arguing petitioners did not have the right to opt out
of TEFRA. Petitioners argued that Mr. Sarma had the right to opt out and that the
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[*14] 2010 notice was invalid on different grounds. The Court granted
respondent’s motion to dismiss, noting the parties agreed that the notice was
invalid. Sarma v. Commissioner, T.C. Dkt. No. 5307-11 (Mar. 16, 2012).
In response to the FPAAs the partnerships filed complaints in the U.S.
District Court for the Middle District of Florida, and their cases were consolidated.
The partnerships filed a motion to dismiss for lack of personal and subject matter
jurisdiction as to Mr. Sarma, arguing that he had the right to opt out of the TEFRA
proceedings because he did not timely receive an NBAP. Kearney, No. 2:10-cv-
153-FtM-SPC, 2013 WL 1232612 (M.D. Fla. Mar. 27, 2013) (order). The District
Court denied the motion, holding that Mr. Sarma did not have a right to receive an
NBAP and therefore did not have the right to opt out of TEFRA. Id. at *5; see sec.
6223(a); sec. 301.6223(c)-1, Proced. & Admin. Regs. (providing manner for
partners to become notice partners).
Following a bench trial the District Court upheld the disallowance of the
Lincoln loss deduction but held that the plaintiffs were not subject to a section
6662(a) accuracy-related penalty on the basis of Mr. Sarma’s participation in the
voluntary disclosure program described in Notice 2002-2, 2002-1 C.B. 304.
Kearney, No 2:10-cv-153-FtM-SPC, 2014 WL 905459 (M.D. Fla. Mar. 7, 2014).
The District Court found that Mr. Sarma “schemed to create and operate the
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[*15] partnerships (even before Mr. Sarma formally purchased them) to serve as
an abusive tax shelter”. Id. at *1. The District Court held: “The FPAAs properly
found that the partnerships lacked economic substance and made adjustments
accordingly”. Id. at *14. It found that every step of the FOCus tax shelter,
including the creation of the partnerships, the FX straddles, Mr. Sarma’s purchase
of Nebraska and Lincoln, the capital contributions, the guaranty, and the sale of
Kearney, was “solely motivated by tax-avoidance.”6 Id. at *13. It found that “the
transactions at issue lacked both economic effects and a legitimate business
purpose and thus are not entitled to tax respect.” Id.
The District Court entered a judgment “in favor of Defendant and against
Plaintiffs as to the lack of economic substance of the partnerships and adjustments
in the FPAAs”, holding that the FPAA adjustments that reallocated income and/or
loss to Mr. Sarma in his individual capacity were moot and not upheld. The
District Court did not make a finding with respect to Lincoln Partners’ outside
basis in its Kearney partnership interest. The U.S. Court of Appeals for the
Eleventh Circuit affirmed the decision on October 13, 2015. Kearney, 803 F.3d
1280.
6
The District Court erroneously stated that Mr. Sarma, rather than Lincoln
Partners, sold the 99% interest in Kearney Partners. We find this error is
immaterial to our decision.
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[*16] On September 9, 2016, respondent issued an affected items notice of
deficiency (2016 notice) to petitioners for 2001 through 2004. The adjustments in
the 2016 notice arise from Mr. Sarma’s participation in the FOCus tax shelter. In
the notice respondent disallowed the deduction of petitioners’ share of the
Lincoln loss on the sale of the Kearney partnership interest, i.e., the Sarma loss,
for 2001 and the capital loss carryforwards for 2002 through 2004 on the basis that
Kearney Partners and Lincoln Partners were shams and disregarded for tax
purposes. The disallowance of the Sarma loss deduction was the only adjustment
except for adjustments to itemized deductions on the basis of statutory limitations
as a result of the loss deduction disallowance. On December 14, 2016, respondent
assessed the tax against petitioners with respect to the adjustments asserted in the
2016 notice and issued a notice of computational adjustment for each year. He
issued the 2016 notice for protective purposes.
III. Nebraska Partners
Nebraska Partners filed a partnership tax return for the short tax period
December 5 to 31, 2001, during which it was a small partnership exempt from
TEFRA. Mr. Sarma directly owned the Nebraska partnership interest from
December 5 to 31, 2001. Nebraska reported a capital loss of $77,613,999 from the
sale of its partnership interest in Lincoln Partners to Mr. Sarma (Nebraska loss) on
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[*17] December 14, 2001, and treated the loss deduction as disallowed under
section 707(b)(1). See sec. 707(b)(1) (providing that no loss deduction shall be
allowed from the sale of property between a partnership and a direct or indirect
partner owning more than a 50% capital or profits interest in the partnership). On
their 2001 joint tax return petitioners reported the Nebraska loss deduction as
disallowed. Treatment of the Nebraska loss is not at issue. Respondent did not
issue an FPAA to Nebraska Partners for the December 5 to 31, 2001, tax period.
Discussion
The parties agree that Lincoln Partners satisfied the definition of a small
partnership under section 6231(a)(1)(B) and was exempt from TEFRA for its
December 31, 2001, tax period, the period of 2001 during which Mr. Sarma was a
direct partner.7 Mr. Sarma was an indirect partner in Lincoln during its December
14, 2001, TEFRA tax period. See sec. 6231(a)(10) (defining an indirect partner as
a “person holding an interest in a partnership through 1 or more pass-through
7
A small partnership is defined as a partnership with 10 or fewer partners
who are individuals (other than nonresident aliens), C corporations, or estates of
deceased partners. Sec. 6231(a)(1)(B)(i). A partnership’s status as a small
partnership is determined annually “with respect to each partnership taxable year.”
Sec. 301.6231(a)(1)-1(a)(3), Proced. & Admin. Regs. A partnership cannot
qualify as a small partnership if any partner is a passthrough partner. Id. subpara.
(2). A passthrough partner is “a partnership, estate, trust, S corporation, nominee,
or other similar person through whom other persons hold an interest in the
partnership”. Sec. 6231(a)(9) (defining a passthrough partner).
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[*18] partners”). Lincoln Partners was a 99% partner of Kearney Partners for
Kearney’s December 19, 2001, TEFRA tax period, during which time Mr. Sarma
was an indirect partner in Lincoln and Kearney.
I. Parties’ Arguments
Petitioners make three arguments in support of their motion to dismiss.
They argue that the Court should dismiss this case whether we apply the TEFRA
procedures or the normal deficiency procedures of subchapter B of chapter 63 of
the Code. The first two arguments depend on whether TEFRA applies despite
Lincoln’s status as a small partnership for its December 31, 2001, tax period.
First, they argue that TEFRA applies for Lincoln’s December 31, 2001, tax period
because the IRS determined that TEFRA applied when it issued an NBAP and
respondent is bound by that determination. They argue that respondent failed to
issue the required FPAA, the 2016 notice is invalid, and the Court lacks
jurisdiction over this case. As an alternative argument, petitioners contend that if
we treat Lincoln Partners as a small partnership exempt from TEFRA, we must
also dismiss. They argue that if Lincoln is a small partnership for its December
31, 2001, tax period, the special statute of limitations rules applicable for TEFRA
partnerships under section 6229 likewise do not apply for the December 31, 2001,
tax period. They argue that the period of limitations is determined under section
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[*19] 6501 and expired no later than February 16, 2013, more than three years
before the 2016 notice was issued. Respondent counters that the adjustments
relate to partnership items from Kearney’s and Lincoln’s prior TEFRA tax periods
even though Lincoln was a small partnership exempt from TEFRA for its
December 31, 2001, tax period. Third, petitioners argue that if we find that the
statute of limitations does not bar assessment, the 2016 notice is invalid because
respondent previously issued two deficiency notices for 2001 through 2004.
Respondent filed a cross-motion to dismiss, also arguing that the 2016
notice is invalid. He argues that the adjustments in the 2016 notice do not require
a partner-level determination and therefore are not subject to the deficiency
procedures. He argues that the partnership-level case determined that Kearney
Partners was a sham and thus Lincoln cannot have an outside basis in its Kearney
partnership interest in excess of zero, citing United States v. Woods, 571 U.S. 31(2013). He argues that no partner-level determinations are required to adjust
Lincoln’s outside basis to zero because taxpayers cannot have basis in an asset that
does not exist for Federal tax purposes. According to respondent’s argument,
outside basis is always zero in a sham partnership and the adjustments at issue are
computational and do not require the issuance of deficiency notices. Accordingly,
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[*20] he argues that the 2016 notice is invalid and we do not have jurisdiction in
this case.
This Court is a court of limited jurisdiction; we may exercise our
jurisdiction only to the extent provided by statute. See sec. 7442; GAF Corp. &
Subs. v. Commissioner, 114 T.C. 519, 521 (2000). We have jurisdiction to
redetermine a deficiency if the Commissioner issues a valid notice of deficiency
and the taxpayer files a timely petition. GAF Corp. & Subs. v. Commissioner, 114
T.C. at 521.
II. Application of TEFRA Procedures
Both parties agree that Lincoln Partners was a small partnership exempt
from TEFRA for its December 31, 2001, tax period. However, petitioners argue
that the IRS determined (although erroneously) through the issuance of the NBAP
in December 2004 and the 2009 notice that TEFRA applied for Lincoln’s
December 31, 2001, tax period. They argue that respondent is bound by that
determination pursuant to section 6231(g)(1) and was required to issue an FPAA
for Lincoln’s December 31, 2001, tax period to make the adjustments he seeks in
this case. According to petitioners, respondent failed to issue an FPAA, and thus
the Court lacks jurisdiction over Lincoln’s December 31, 2001, tax period and
lacks jurisdiction to disallow the Sarma loss deduction. We find that neither the
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[*21] NBAP nor the 2009 notice constitutes a determination by respondent to treat
Lincoln Partners as a TEFRA partnership for its December 31, 2001, tax period.
For the reasons set forth below, we hold that respondent did not determine that
TEFRA applied for Lincoln’s December 31, 2001, tax period.
Under section 6231(g)(1), when the Commissioner erroneously determines
that TEFRA applies to a non-TEFRA partnership, the partnership will be subject
to TEFRA so long as that determination was reasonable on the basis of the
partnership’s tax return. When the Commissioner makes a reasonable but
erroneous determination on the basis of a partnership return that TEFRA applies to
a small partnership, a partnership that should be subject to the normal deficiency
procedures will instead be subject to the TEFRA procedures. Conversely, TEFRA
will not apply to a TEFRA partnership where the Commissioner has reasonably
but erroneously determined on the basis of a partnership return that TEFRA does
not apply. Sec. 6231(g)(2). Respondent maintains that he did not determine that
TEFRA applied for Lincoln’s December 31, 2001, tax period, and if the Court
finds that he made such a determination, that determination was not reasonable
because Lincoln Partners’ December 31, 2001, tax return clearly shows that it was
a small partnership and Lincoln did not file an attachment to the return electing to
have TEFRA apply.
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[*22] Section 6231(g)(1) was intended to protect the Commissioner where he
makes an erroneous determination on the basis of a partnership return that a small
partnership is subject to TEFRA so long as his determination was reasonable.
Bedrosian v. Commissioner, 143 T.C. 83, 104-105 (2014). It is a relief provision
for the IRS. The Code grants this relief because of the difficulty that the IRS may
have when determining whether a partnership is subject to TEFRA. Id. at 105.
Congress’ purpose for enacting section 6231(g) was “to simplify the IRS’ task of
choosing between the TEFRA procedures and the normal deficiency procedures
by permitting the IRS to rely on the partnership’s return.” Id. However,
petitioners attempt to use section 6231(g)(1) as a punitive measure against
respondent on the basis of certain statements on Lincoln’s December 31, 2001,
return that conflict with its small partnership status.
On Lincoln’s December 31, 2001, return it answered “yes” to question 4
asking whether TEFRA applied, and it named a tax matters partner. The return
shows that the partnership had two partners and that neither partner was the type
of partner that would cause TEFRA to automatically apply. See sec.
6231(a)(1)(B)(i) (setting forth the criteria for a small partnership). Notably,
Lincoln Partners did not follow the rules set forth in the regulations or the 2001
Instructions for Form 1065, U.S. Partnership Return, which state: “Caution! This
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[*23] partnership does not make this election when it answers Yes to Question 4.
The election must be made separately.” Lincoln did not attach a statement to its
December 31, 2001, return to elect to have TEFRA apply as required by the
regulations or Form 1065 Instructions. See sec. 6231(a)(1)(B)(ii); sec.
301.6231(a)(1)-1(b)(2), Proced. & Admin. Regs. (the method for a small
partnership to elect to apply TEFRA is to attach a statement to its return).
If section 6231(g)(1) applies, it would render Lincoln Partners subject to
TEFRA for the December 31, 2001, tax period even though the parties agree that it
fell within the small partnership exception. For section 6231(g)(1) to apply, three
events must occur: (1) the IRS determined on the basis of Lincoln Partners’ return
that it was subject to TEFRA, (2) the determination was erroneous, and (3) the
determination was reasonable. When the Commissioner issues multiple notices
with conflicting determinations regarding TEFRA’s applicability, the first notice
controls. Bedrosian v. Commissioner, 143 T.C. at 108 (the Commissioner issued
an FPAA followed by a notice of deficiency). We conclude infra that respondent
did not determine that TEFRA applied for Lincoln’s December 31, 2001, tax
period. The second factor is not at issue; the parties agree that such a
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[*24] determination would have been erroneous because Lincoln was a small
partnership for its December 31, 2001, tax period.8
In considering the first factor we must address a threshold question of
whether the IRS made a determination that TEFRA applies, and a secondary
question of what type of notice from the IRS constitutes a determination.
Petitioners argue that the 2009 notice and the NBAP constitute a determination by
respondent. We disagree. The 2009 notice is not a determination for purposes of
section 6231(g). For section 6231(g) to apply, the Commissioner must make a
single partnershipwide determination regarding TEFRA’s applicability. Bedrosian
v. Commissioner, 143 T.C. at 109. In the 2009 notice respondent determined that
petitioners were not entitled to deduct the portion of the Lincoln loss allocated to
Mr. Sarma. Respondent did not make a partnershipwide determination and
accordingly did not make a determination regarding TEFRA’s applicability for
purposes of section 6231(g). As the 2009 notice was not a partnershipwide
adjustment, the notice does not constitute a determination under section 6231(g).
Even if the 2009 notice made partnershipwide adjustments, the notice could
not constitute a determination because it was invalid as to the adjustments relating
8
As we find that respondent did not determine that TEFRA applied for
Lincoln’s December 31, 2001, tax period, we do not consider whether such a
determination would have been reasonable, the third factor.
- 25 -
[*25] to the partnership and affected items. We dismissed the partnership and
affected items in Sarma I. Petitioners argue that the dismissal in Sarma I is
consistent with a determination that TEFRA applied for Lincoln’s December 31,
2001, tax period. They characterize the decision in Sarma I as finding that Mr.
Sarma would not have affected items from Kearney and Kearney cannot affect
their 2001 tax liability. However, our decision to dismiss with respect to the
partnership and affected items did not result from a finding that Lincoln’s
December 31, 2001, tax period was subject to TEFRA. While petitioners argued
for dismissal in Sarma I as to the partnership and affected items adjustments,
respondent issued the 2009 notice with respect to these adjustments for protective
purposes. In Sarma I respondent stated to the Court that Lincoln was a small
partnership for its December 31, 2001, tax period and the three partnerships were
subject to TEFRA for “certain” tax periods during 2001 in clear contradiction to
petitioners’ characterization of that case. Respondent did not take the position that
TEFRA applied for Lincoln’s December 31, 2001, tax period. Rather, the decision
in Sarma I is consistent with a determination that Lincoln is not subject to TEFRA
for its December 31, 2001, tax period.
Nor does the NBAP constitute a determination by the Commissioner that
TEFRA applies for purposes of section 6231(g). The Commissioner makes a
- 26 -
[*26] determination when he issues the notice that concludes the examination.
Bedrosian v. Commissioner, 143 T.C. at 106-107. We have held that an FPAA is
the Commissioner’s determination of TEFRA’s applicability; inherent in the
issuance of an FPAA is a determination that TEFRA applies. Id. at 107; see
Clovis I v. Commissioner, 88 T.C. 980, 982 (1987). Respondent did not issue an
FPAA for Lincoln’s December 31, 2001, tax period. Accordingly, he did not
make a determination that TEFRA applied for that tax period. See Bedrosian v.
Commissioner, 143 T.C. at 107-108 (events occurring during the examination are
not determinative as to whether TEFRA applies). Furthermore, nothing in the
Code nor the regulations requires the Commissioner to make an adjustment or
issue a notice following the conclusion of an audit. See sec. 6223 (relating to
issuance of notices at beginning and conclusion of partnership audit). We hold
that section 6231(g) does not apply, and Lincoln’s December 31, 2001, tax period
is not subject to TEFRA.
Petitioners also argue that the NBAP should control because Mr. Sarma did
not receive notice at the end of Lincoln’s audit that TEFRA did not apply for
Lincoln’s December 31, 2001, tax period. They argue that they reasonably relied
on the NBAP and reasonably expected respondent to issue an FPAA. They argue
that respondent had a duty to inform them that he would not issue an FPAA and
- 27 -
[*27] did not notify them that one would not be issued. They argue that the
issuance of the NBAP should control because the Commissioner must determine
whether to apply TEFRA or the normal deficiency procedures at the beginning of
a partnership audit. They emphasize the importance of the beginning of the audit
because, they argue, if TEFRA does not apply, the Commissioner must deal
directly with each partner during the audit rather than the TEFRA tax matters
partner. They rely on a statement in Harrell v. Commissioner, 91 T.C. 242, 246
(1988), that a determination “should be made by respondent as of the date of
commencement of the audit of the partnership (but not necessarily on that date) by
examining the partnership return * * * prior to this date.” Harrell does not support
petitioners’ argument that the Commissioner must definitively determine
TEFRA’s applicability at the beginning of the audit or that a revenue agent’s
initial decision to issue an NBAP controls. It was not reasonable for Mr. Sarma to
expect respondent to issue an FPAA for Lincoln’s December 31, 2001, tax period
as its status as a small partnership is clear on the partnership return and it did not
file the required attachment to make an election.
Moreover, respondent did not have a duty to inform petitioners that he
would not issue an FPAA. Petitioners do not cite any authority in the Code or the
regulations to support their argument that respondent had such a duty. There is no
- 28 -
[*28] basis to impose a duty on respondent to inform petitioners that he would not
issue an FPAA. In Sarma I respondent stated that Lincoln was a small partnership
for the December 31, 2001, tax period, so petitioners should have known no FPAA
would be issued. Revenue Agent Rickard issued an NBAP for Lincoln’s
December 31, 2001, tax period and information document requests to Lincoln’s
tax matters partner. In mid-2004 the examination of the partnerships’ and
petitioners’ returns was transferred to Revenue Agent Scheick, and she determined
that TEFRA did not apply for that tax period. She began treating Lincoln Partners
as a non-TEFRA partnership for its December 31, 2001, tax period approximately
one year after the NBAP for Lincoln was issued and approximately five years
before the 2009 notice and the FPAAs for the TEFRA tax periods were issued.
Under these facts any expectation on Mr. Sarma’s part that respondent would issue
an FPAA for Lincoln’s December 31, 2001, tax period would not have been
reasonable.
In summary, respondent was not required to issue an FPAA for Lincoln’s
December 31, 2001, tax period to make the adjustments he seeks in this case. We
will deny petitioners’ motion to dismiss with respect to this argument.
- 29 -
[*29] III. Application of Section 6229 Special Statute of Limitations Rules
As we have found that respondent was not required to issue an FPAA for
Lincoln’s December 31, 2001, tax period, we next consider petitioners’ argument
that the statute of limitations under section 6501 bars assessment. The statute of
limitations is an affirmative defense and does not raise a jurisdictional issue. See
sec. 6213(a) (our jurisdiction to redetermine a deficiency depends on the issuance
of a notice of deficiency and filing of a petition); Davenport Recycling Assocs. v.
Commissioner, 220 F.3d 1255, 1259 (11th Cir. 2000), aff’g T.C. Memo. 1998-
347; Columbia Bldg., Ltd. v. Commissioner, 98 T.C. 607, 611 (1992). Thus, the
Court would not lose jurisdiction even if petitioners are correct that the statute of
limitations bars assessment. As a result we will treat petitioners’ statute of
limitations argument as a motion for summary judgment. A motion for summary
judgment may be granted where the pleadings and other materials show that there
is no genuine issue as to any material fact and that a decision may be rendered as a
matter of law. Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520
(1992), aff’d, 17 F.3d 965 (7th Cir. 1994). The burden is on the moving party to
show that there is no genuine dispute of material fact and he is entitled to
judgment as a matter of law. FPL Grp., Inc. & Subs. v. Commissioner, 116 T.C.
73, 74-75 (2001). In summary judgment cases the evidence is viewed in the light
- 30 -
[*30] most favorable to the nonmoving party. Bond v. Commissioner, 100 T.C.
32, 36 (1993).
Section 6229 extends the period of limitations for assessment prescribed by
section 6501 with respect to partnership and affected items. See sec. 6501(n)(2);
Rhone-Poulenc Surfactants & Specialities, L.P. v. Commissioner, 114 T.C. 533,
540-543 (2000). It applies to assessments of tax “with respect to any person
which is attributable to any partnership item (or affected item) for a partnership
taxable year.” Sec. 6229(a). Under section 6229(a) the period of limitations for
TEFRA partnerships is triggered by the later of (1) the filing of the partnership tax
return or (2) the last day for filing the return. The timely mailing of an FPAA
suspends the running of the limitations period for assessing any income tax that is
attributable to any partnership item or affected item. See sec. 6229(d). The
limitations period remains suspended for the period during which an action may be
filed in court, during the pendency of any proceeding actually brought, and for one
year thereafter. Id. For a non-TEFRA small partnership, however, the limitations
period is generally triggered upon the filing of the partner’s return, not the
partnership return. Wolf v. Commissioner, 4 F.3d 709, 714 (9th Cir. 1993), aff’g
T.C. Memo. 1991-212.
- 31 -
[*31] Petitioners do not dispute that the period of limitations would remain open
if section 6229 applied. If section 6229 applied, the period of limitations for
assessments with respect to the Sarma loss would expire one year after the District
Court’s decision became final, January 11, 2017. Rather, they argue that section
6229 special statute of limitations rules for TEFRA partnerships cannot apply for a
small partnership exempt from TEFRA. They argue that section 6229 does not
apply for Lincoln’s December 31, 2001, tax period and the December 31, 2001,
tax period was the only tax period during which Mr. Sarma owned a direct interest
in Lincoln. They argue that the period of limitations under section 6501 has
expired. We hold that the special statute of limitations rules for TEFRA
partnerships under section 6229 apply for Lincoln’s non-TEFRA December 31,
2001, tax period and extend the period of limitations for petitioners’ 2001 tax year.
By its terms, section 6229 applies only to partnership or affected items.
Petitioners argue that as a small partnership Lincoln Partners cannot have
partnership or affected items and thus section 6229 does not apply. They argue a
small partnership can have only nonpartnership items, citing Nehrlich v.
Commissioner, T.C. Memo. 2007-88, aff’d, 327 F. App’x 712 (9th Cir. 2009), and
Am. Milling, L.P. v. Commissioner, T.C. Memo 2015-192. According to
petitioners, the Lincoln loss was a nonpartnership item of a small partnership. In
- 32 -
[*32] Nehrlich v. Commissioner, slip op. at 7, we wrote: “TEFRA then defines
‘partnership’ to exclude small partnerships * * * and this then excludes them from
TEFRA procedures because a small partnership would have only nonpartnership
items”. Petitioners argue that in Am. Milling, L.P. we held that TEFRA
partnerships have partnership items and by analogy a small partnership can have
only nonpartnership items.
While petitioners may be correct that a small partnership may not have
partnership or affected items flowing from it, a small partnership can have affected
items from its participation in other TEFRA partnerships. A partnership item is
“any item required to be taken into account for the partnership’s taxable year
under any provision of Subtitle A [Income Taxes] to the extent [the] regulations
* * * provide that, for purposes of this subtitle, such item is more appropriately
determined at the partnership level than at the partner level.” Sec. 6231(a)(3). A
nonpartnership item is an “item which is (or treated as) not a partnership item.”
Id. para. (4). An affected item is any item to the extent it is affected by the
determination of a partnership item. Id. para. (5). Generally, outside basis is an
affected item. Woods, 571 U.S. at 41; Petaluma FX Partners, LLC v.
Commissioner, 591 F.3d 649, 655 (D.C. Cir. 2010), aff’g in part, rev’g and
remanding in part 131 T.C. 84 (2008); see sec. 301.6231(a)(5)-1(b), Proced. &
- 33 -
[*33] Admin. Regs. A computational adjustment is “the change in the tax liability
of a partner which properly reflects the treatment * * * of a partnership item. All
adjustments required to apply the results of a proceeding with respect to a
partnership * * * to an indirect partner shall be treated as computational
adjustments.” Sec. 6231(a)(6).
Lincoln Partners was a TEFRA partnership and became a small partnership
exempt from TEFRA for a subsequent tax period, i.e., the December 31, 2001, tax
period. During the non-TEFRA small partnership tax period, Lincoln owned an
interest in a TEFRA partnership, Kearney Partners. Lincoln’s sale of the Kearney
partnership interest generated the Lincoln loss that passed through to Mr. Sarma as
Lincoln’s partner during Lincoln’s small partnership tax period. Lincoln’s outside
basis in Kearney is an affected item from the TEFRA partnership proceeding.
Lincoln Partners was a direct partner and Mr. Sarma was an indirect partner of
Kearney Partners during its TEFRA tax period, ending upon the sale of Lincoln’s
interest in Kearney, i.e., the December 19, 2001, TEFRA tax period. TEFRA
applies to any entity with respect to any taxable year that files a partnership return
and to any person holding an interest in such entity either directly or indirectly at
any time during that taxable year. Sec. 301.6233-1(a), Admin. & Proced. Regs.
- 34 -
[*34] For purposes of TEFRA, an indirect partner is a partner.9 See sec.
6231(a)(9) (defining passthrough partner) and (10) (defining indirect partner). An
adjustment to an affected item from the TEFRA proceeding applies to an indirect
partner.
Once a partnership item is determined the Commissioner may adjust items
attributable to the partnership items to determine and change a partner’s tax
liability attributable to the partnership items. The adjustments may occur in tax
periods following the periods at issue in the TEFRA proceeding. See Kligfeld
Holdings v. Commissioner, 128 T.C. 192, 199-207 (2007). The adjustment to the
Lincoln loss, which passed through to Mr. Sarma (Sarma loss), resulted from the
Kearney TEFRA proceeding. Kearney’s December 19, 2001, TEFRA tax period
ended within Lincoln’s December 31, 2011, small partnership tax period and
petitioners’ 2001 tax year. Thus, the TEFRA decision enters into Lincoln’s
computation of its gain or loss on the sale of its Kearney partnership interest
during its December 31, 2001, tax period even though Lincoln was a small
partnership during that tax period and even though Lincoln’s December 31, 2001,
tax period was not at issue in Kearney. The fact that Lincoln was a small
9
A partner is defined as either (1) a partner in the partnership or (2) any
other person whose income tax liability is determined directly or indirectly by
taking partnership items into account. Sec. 6231(a)(2).
- 35 -
[*35] partnership during the tax period in which it sustained the subject loss is not
relevant.
Mr. Sarma was a partner in Lincoln during Kearney’s TEFRA tax period
when the Lincoln loss arose, the December 19, 2001, tax period, and over which
the District Court had jurisdiction. Accordingly, he was a person to which a
partnership item or an affected item was attributable. Thus, the Kearney decision
can result in affected items to Mr. Sarma and may affect his 2001 tax liability.
Lincoln’s outside basis in Kearney Partners is an affected item. It affected the
amount of Lincoln’s loss on the sale of Kearney. The loss passed through to Mr.
Sarma as a partner in Lincoln, and he deducted his share of the Lincoln loss, i.e.,
the Sarma loss. The Sarma loss is attributable to the partnership items determined
in Kearney.
Section 6229 extends the period of limitations for assessing tax attributable
to partnership items and affected items following the conclusion of a TEFRA
proceeding. It applies to determine the period of limitations to assess tax against
the partners attributable to the partnership items and affected items. Those
affected items arose in Lincoln’s December 31, 2001, tax period when it was a
small partnership. Accordingly, section 6229 can apply to a non-TEFRA small
partnership where the small partnership has affected items from a TEFRA
- 36 -
[*36] proceeding. It extends the limitations period to assess tax attributable to the
affected items with respect to Mr. Sarma because he was an indirect partner in
Kearney Partners for the TEFRA tax periods irrespective of the fact that the loss
passed through to Mr. Sarma during Lincoln’s non-TEFRA tax period.
Accordingly, the period of limitations has not expired for petitioners’ 2001
through 2004 tax years with respect to the Sarma loss, and we will deny
petitioners’ motion with respect to their statute of limitations argument.
IV. Partner-Level Determination
We next address respondent’s motion to dismiss for lack of jurisdiction.
Under section 6226(f) a court’s jurisdiction in a TEFRA partnership-level
proceeding extends to all partnership items for the partnership taxable year to
which the FPAA relates, the proper allocation of the partnership items among the
partners, and the applicability of any penalty, addition to tax, or additional amount
that relates to an adjustment to a partnership item. Once the partnership-level
adjustments become final, the Commissioner must initiate further action at the
partner level to make any resulting adjustments to the tax liabilities of the
individual partners. The Commissioner must follow the deficiency notice
procedures under sections 6211 through 6216 for adjustments attributable to
affected items that require partner-level determinations. Sec. 6230(a)(2)(A)(i);
- 37 -
[*37] sec. 301.6231(a)(6)-1(a)(3), Proced. & Admin. Regs. In such a case the
partner has a prepayment forum to challenge the Commissioner’s determination.
Sec. 6230(a)(2)(A)(i).
The deficiency notice procedures do not apply to an adjustment to an
affected item that does not require a partner-level determination. Id. para. (1). If
no partner-level determination is required, the adjustment is computational and the
Commissioner can directly assess the resulting tax deficiency against each partner
without issuing a notice of deficiency. Id.; sec. 301.6231(a)(6)-1(a)(2), Proced. &
Admin. Regs. The partner would not have access to the deficiency procedures to
challenge the Commissioner’s computational adjustments. Instead, he must file a
claim for refund and rely on refund litigation if the refund claim is denied. See
sec. 6230(a)(1), (c)(4).
Respondent moves for dismissal, arguing that the adjustments at issue are
computational and do not require any partner-level determinations on the basis of
the decision in Kearney that Kearney Partners was a sham for its December 19,
2001, tax period. He argues that Lincoln’s outside basis in the sham Kearney
partnership must be zero without any further partner-level determinations and thus
Lincoln could not have sustained a loss on the sale of its Kearney partnership
interest to pass through to Mr. Sarma. According to respondent, the deficiency
- 38 -
[*38] procedures do not apply, the 2016 notice is invalid, and we should dismiss
on the basis of lack of jurisdiction. Respondent directly assessed tax against
petitioners attributable to the disallowance of the Sarma loss deduction and issued
the 2016 notice as a protective measure.
Petitioners argue that outside basis must be determined at the partner level
and not assumed to be zero irrespective of the decision in a partnership-level case
that the partnership was a sham. They argue that a computational adjustment
means only an adjustment that can be made with a mathematical computation.
They also renew their argument that the Lincoln loss and its outside basis in
Kearney Partners are nonpartnership items on the basis that Lincoln cannot have
any affected items from TEFRA because Lincoln was a non-TEFRA small
partnership for its December 31, 2001, tax period. We have found that a small
partnership that owns an interest in a TEFRA partnership can have affected items
from the TEFRA partnership, and we will not revisit this argument. The issue is
whether a partner-level determination is required to adjust a purported partner’s
outside basis in a sham partnership to zero.
A partner’s outside basis in his partnership interest is “an affected item to
the extent it is not a partnership item.” Sec. 301.6231(a)(5)-1(b), Proced. &
- 39 -
[*39] Admin. Regs. Following disagreement among the Courts of Appeals,10 the
Supreme Court decided that a court in a partnership-level TEFRA proceeding has
jurisdiction to provisionally determine an accuracy-related penalty relating to the
portion of any underpayment that is attributable to a valuation misstatement of
outside basis. Woods, 571 U.S. 31. The Supreme Court recognized that a
partner’s outside basis is a nonpartnership item that the courts do not have
jurisdiction to adjust in a TEFRA partnership-level proceeding. Id. at 41. Outside
basis must be adjusted at the partner level. Id. However, it reasoned that “once
the partnerships were deemed not to exist for tax purposes, no partner could
legitimately claim an outside basis greater than zero”, id. at 44, and the court in a
partnership-level proceeding where the partners’ liability for a penalty is at issue is
“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”, id. at 42. Thus, a court has jurisdiction to determine the penalty “even if
10
Thompson v. Commissioner, 729 F.3d 869, 872 (8th Cir. 2013), rev’g and
remanding 137 T.C. 220 (2011); Jade Trading, LLC v. United States, 598 F.3d
1372, 1380 (Fed. Cir. 2010); Petaluma FX Partners, LLC v. Commissioner, 591
F.3d 649, 655 (D.C. Cir. 2010), aff’g in part, rev’g and remanding in part 131 T.C.
84 (2008); Tigers Eye Trading, LLC v. Commissioner, 138 T.C. 67, 117 (2012),
aff’d in part, rev’d in relevant part sub nom. Logan Tr. v. Commissioner, 616 F.
App’x 426 (D.C. Cir. 2015). These cases, with the exception of Thompson, each
involved a court’s jurisdiction in a partnership-level proceeding. Here we
determine our jurisdiction in a partner-level case.
- 40 -
[*40] imposing the penalty would also require determining affected or non-
partnership items such as outside basis.” Id. at 41. However, a court would not
have jurisdiction to “make a formal adjustment” to the partner’s outside basis. Id.
at 42; see also Logan Tr. v. Commissioner, 616 F. App’x. 426, 429 (D.C. Cir.
2015), aff’g in part, rev’g in relevant part Tigers Eye Trading, LLC v.
Commissioner, 138 T.C. 67 (2012); Petaluma FX Partners, LLC v. Commissioner,
591 F.3d at 654-655.
Respondent attempts to distinguish an impermissible adjustment of outside
basis from a determination that outside basis in a sham partnership is zero. The
determination of whether a TEFRA partnership is a sham or bona fide is a
partnership item properly made at the partnership level. Petaluma FX Partners,
LLC v. Commissioner, 591 F.3d at 652-654. Respondent argues that once a
partnership-level case determines the partnership was a sham, the adjustment of
outside basis to zero does not require a partner-level determination. In dicta,
responding to a point raised in an amicus brief, the Supreme Court in Woods
observed that where a partnership is a sham and disregarded for tax purposes, the
determination of the partner’s outside basis may not require a partner-level
determination to adjust outside basis and thus the adjustment may be
computational. Woods, 571 U.S. at 42 n.2. The Court stated that the amici’s
- 41 -
[*41] argument “assumes that the underpayment would not be exempt from
deficiency proceedings because it would rest on outside basis.” Id. The Court
further observed: “Even an underpayment attributable to an affected item is
exempt so long as the affected item does not ‘require partner-level
determinations,’ * * * and it is not readily apparent why additional partner level
determinations would be required before adjusting outside basis in a sham
partnership.” Id. (citations omitted).
Woods did not, however, answer the question of whether the partner-level
adjustment of outside basis incident to a deficiency determination is computational
and the Commissioner may directly assess the resulting tax against the purported
partners or whether the adjustment requires a partner-level determination and the
issuance of a notice of deficiency. We have stated that Woods provided “no direct
answer” to this question. Thompson v. Commissioner, T.C. Memo. 2014-154, at
*7 n.4, aff’d, 821 F.3d 1008 (8th Cir. 2016). We have also suggested in dicta that
in cases involving sham, disregarded partnerships, an adjustment to zero of a
purported partner’s outside basis does not require “further partner-level
determinations” because outside basis is automatically zero. Greenwald v.
Commissioner, 142 T.C. 308, 316 (2014). Greenwald involved a bona fide
partnership where a partner-level determination would be required to determine
- 42 -
[*42] outside basis. However, in Greenwald we relied on Tigers Eye Trading,
LLC v. Commissioner, 138 T.C. 67, which was subsequently reversed. Logan Tr.
v. Commissioner, 616 F. App’x 426.
At the outset we note that partner-level determinations are clearly necessary
relating to the tax treatment of the assets distributed in a liquidation from a sham
partnership irrespective of the fact that the partnership is a sham. Napoliello v.
Commissioner, 655 F.3d 1060 (9th Cir. 2011), aff’g T.C. Memo. 2009-104;
Domulewicz v. Commissioner, 129 T.C. 11, 20 (2007), aff’d in part, rev’d in part
sub nom. Desmet v. Commissioner, 581 F.3d 297 (6th Cir. 2009). Partner-level
determinations are required regarding the reporting of the subsequent disposition
of the distributed assets by the purported partners, including the partners’ holding
periods of the assets, the character of the gain or loss on the disposition of the
assets, and whether the disposed assets were in fact the assets distributed by the
sham partnership. Domulewicz v. Commissioner, 129 T.C. at 20. In this case
there was no liquidating distribution of assets from a sham partnership.
When a court in a partnership-level case holds that a partnership is a sham,
the logical conclusion is that the purported partners would not have outside bases
in the sham partnership greater than zero that would allow the purported partners
to claim loss deductions on the sale of their partnership interests. A taxpayer
- 43 -
[*43] cannot have a basis in an asset that does not exist for Federal tax purposes.
Woods, 571 U.S. at 41; Logan Tr. v. Commissioner, 616 F. App’x at 429 (where a
partnership is a sham and “never existed, * * * no partner could have any outside
basis in the entity”); Greenwald v. Commissioner, 142 T.C. at 314-315. This
conclusion, however, does not confer jurisdiction on the Court in a partnership-
level case to determine outside basis. Woods, 571 U.S. at 41. We note that the
District Court in Kearney did not make any findings with respect to Lincoln’s
outside basis in Kearney Partners; it was without jurisdiction to make any such
findings.
Under section 6226(f) a court reviewing a petition for readjustment of
partnership items generally has jurisdiction to determine “partnership items * * *
[and] the proper allocation of such items among the partners”. However, in the
limited instance of an accuracy-related penalty relating to outside basis, section
6226(f) specifically grants the Court jurisdiction to provisionally impose the
penalty that “relates to an adjustment to a partnership item” even though the
penalty may depend on partner-level determinations. Thus, the Court can
provisionally determine the penalty on the basis of another determination that it
does not have jurisdiction to make.
- 44 -
[*44] The Supreme Court recognized that “every penalty must be imposed in
partner-level proceedings after partner-level determinations”. Woods, 571 U.S. at
41. Likewise, the determination of a partner’s outside basis can be made only at
the partner level after partner-level determinations. Thompson v. Commissioner,
729 F.3d 869, 872 (8th Cir. 2013); Petaluma FX Partners, LLC v. Commissioner,
591 F.3d at 654-655 (acknowledging a sham partnership results in an outside basis
of zero but holding that the court in a partnership-level case does not have
jurisdiction to determine outside basis). A partner-level determination is required
even where the partnership is a sham.
While the Supreme Court’s dicta in Woods gives us pause, we conclude that
the adjustment of outside basis in a sham partnership requires a partner-level
determination. No Court of Appeals has discussed the question of whether the
adjustment of outside basis could be computational. At this late date in the life of
the TEFRA partnership provisions, it would be unwise for us to introduce
uncertainty in the application of this well-worn law.11 It is logical, as the Supreme
Court suggests, to conclude Lincoln’s outside basis in its Kearney partnership
interest was zero. If so, Lincoln could not have incurred a loss on the sale of its
11
Congress repealed the TEFRA procedures in the Bipartisan Budget Act of
2015, Pub. L. No. 114-74, sec. 1101(a), 129 Stat. at 625.
- 45 -
[*45] Kearney partnership interest to pass through to Mr. Sarma. “Neither the
Code nor the regulations * * * require that partner-level determinations actually
result in a substantive change to a determination made at the partnership level.”
Domulewicz v. Commissioner, 129 T.C. at 20. The adjustment to outside basis is
made at the partner level and requires a partner-level determination. Accordingly,
the 2016 notice is valid, and we will deny respondent’s motion to dismiss.
Petitioners advance a number of objections relating to the Kearney decision
and argue that its findings are irrelevant and erroneous, resulting in a need for
partner-level determinations. It appears that petitioners seek to relitigate the issues
decided in Kearney; they have yet to identify any component of outside basis left
unresolved after Kearney Partners was held to be a sham or to articulate a position
for the Court to find that Lincoln’s outside basis in Kearney was greater than zero.
They argue that the District Court did not have jurisdiction over Mr. Sarma
because he was not a party in that case, Mr. Sarma opted out of Kearney, and
finally Kearney supports the deduction of the Sarma loss because the District
Court reallocated the gain and loss from the FX straddles to Mr. Sarma in his
individual capacity after holding the three partnerships were shams. They also
argue that Sarma I supports their position that Mr. Sarma was not a partner during
the TEFRA tax periods and is not bound by Kearney.
- 46 -
[*46] As explained the Kearney decision may result in adjustments to affected
items for tax periods over which the District Court lacked jurisdiction. The
decision may change a partner’s tax liability in a tax period different from the
period at issue in the TEFRA proceedings. See Kligfeld Holdings v.
Commissioner, 128 T.C. at 199-207. In Sarma I the parties merely stipulated that
petitioners did not concede they had an interest in Kearney or concede that it could
affect their tax liabilities for 2001 through 2004. Mr. Sarma did not have the right
to opt out of TEFRA because he was not a notice partner with the right to receive
the NBAP. See sec. 6223(e) (providing notice partners with statutory rights where
an NBAP is not timely issued). The District Court held that Mr. Sarma did not
elect to opt out of TEFRA. Kearney, 2013 WL 1232612 at *5-*7. Although
respondent mistakenly included a letter in the FPAA stating that Mr. Sarma had a
right to opt out of TEFRA because of an untimely NBAP, he later informed Mr.
Sarma of this mistake. As no FPAA is required for Lincoln’s December 31, 2001,
tax period, no right to opt out of TEFRA can arise.
Petitioners argue in the alternative that Kearney supports their entitlement to
loss deductions because the District Court sustained the FPAA adjustments and
reallocated the income and loss from the FX straddles to Mr. Sarma in his
individual capacity. Accordingly, they argue that Mr. Sarma had bases in the FX
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[*47] straddles to claim loss deductions on the transactions. We reject petitioners’
characterization of Kearney; it did not reallocate the FX straddle income and
losses to Mr. Sarma. The District Court sustained the adjustments in the FPAAs,
which included reallocation of the gain and loss from the FX straddles to Mr.
Sarma. Petitioners argue that in the FPAAs respondent recognized the FX
straddles for tax purposes. However, the District Court found that the FX
straddles were shams and disregarded for Federal tax purposes. In its judgment
the District Court held the portion of the FPAAs that reallocated the income and
loss to Mr. Sarma to be moot. Accordingly, the District Court did not reallocate
the income and loss from the FX straddles to Mr. Sarma.
V. Multiple Notices of Deficiency
Generally the Commissioner is precluded from issuing more than one notice
of deficiency for a taxable year. Sec. 6212(c). An exception to the one deficiency
notice rule exists for affected items that require partner-level determinations. Sec.
6230(a)(2)(C). Petitioners argue that the Sarma loss is not an affected item and
not a computational adjustment. They argue that respondent was precluded from
issuing the 2016 notice because it is an invalid further notice of deficiency for
2001 through 2004. For the reasons stated above, the Sarma loss deduction is an
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[*48] affected item that requires a partner-level determination. The exception
applies. Accordingly, respondent is not precluded from issuing the 2016 notice.
In reaching our holding, we have considered all arguments made, and, to the
extent not mentioned above, we conclude that they are moot, irrelevant, or without
merit.
To reflect the foregoing,
An appropriate order will be issued.