Petaluma FX Partners, LLC, Ronald Scott Vanderbeek, A Partner Other Than the Tax Matters Partner v. Commissioner

131 T.C. No. 9UNITED STATES TAX COURT
PETALUMA FX PARTNERS, LLC, RONALD SCOTT VANDERBEEK, A PARTNER
OTHER THAN THE TAX MATTERS PARTNER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24717-05. Filed October 23, 2008.
P challenges adjustments in a final partnership
administrative adjustment (FPAA) issued to a
partnership (PFP). P stipulated most of the
adjustments in the FPAA and argues that the Court lacks
jurisdiction over the remaining determinations. P
stipulated that he will not contest any determinations
in the FPAA over which the Court finds it has
jurisdiction except for the valuation penalties, which
P argues do not apply to the partnership items at issue
as a matter of law. R argues that all remaining
determinations in the FPAA are partnership items or are
otherwise within the Court’s jurisdiction and therefore
seeks summary judgment on all remaining issues.
Held: The issue of whether PFP should be
disregarded for tax purposes is a partnership item.
Held, further, because we conclude that we have
jurisdiction to determine that PFP should be
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disregarded for tax purposes, we may determine that the
partners had no outside bases in PFP.
Held, further, the Court has jurisdiction to
determine whether a valuation misstatement penalty
applies.
Held, further, because P stipulated that he will
not contest any determinations in the FPAA over which
the Court determines it has jurisdiction and the Court
finds it has jurisdiction over all determinations
necessary to support the adjustments in the FPAA, we
shall grant R’s motion for summary judgment and deny
petitioner’s cross-motion for summary judgment.
Edward M. Robbins, Jr., for petitioner.
Gerald A Thorpe and Jason M. Kuratnick, for respondent.
OPINION
GOEKE, Judge: This case is before the Court on the parties’
cross-motions for summary judgment under Rule 121.1 The issues
for decision are: (1) Whether the Court has jurisdiction in this
partnership-level proceeding to determine whether Petaluma FX
Partners, L.L.C. (Petaluma) should be disregarded for tax
purposes; (2) whether the Court has jurisdiction to determine
whether the partners’ outside bases in Petaluma were greater than
zero; (3) whether the Court has jurisdiction to determine whether
the accuracy-related penalties determined in a notice of final
1
Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code (Code) in effect for
the year at issue.
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partnership administrative adjustment (FPAA) apply; (4) if the
Court has jurisdiction to review the application of the accuracy-
related penalties determined in the FPAA, whether the substantial
valuation misstatement penalties are applicable to the
adjustments of partnership items; and (5) whether the Court has
jurisdiction to review the remaining determinations made in the
FPAA.
For the reasons discussed below, we shall grant respondent’s
motion for summary judgment and deny petitioner’s cross-motion
for summary judgment.
Background
Petaluma, a purported partnership,2 was formed in August
2000. Bricolage Capital, L.L.C.; Stillwaters, Inc.; and Caballo,
Inc., executed the operating agreement for the partnership.
Petaluma’s alleged business purpose was to engage in foreign
currency option trading on behalf of its partners. On or about
October 10, 2000, Ronald Thomas Vanderbeek (RTV) and Ronald Scott
Vanderbeek (RSV) became partners of Petaluma by contributing
pairs of offsetting long and short foreign currency options. In
computing their adjusted bases in their interests in Petaluma,
RTV and RSV increased their adjusted bases to reflect their
contributions of the long options to Petaluma but did not
2
Respondent argues that Petaluma was not a partnership for
tax purposes. We use the terms “partnership”, “partner”, and
related terms for convenience.
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decrease their adjusted bases to reflect Petaluma’s assumption of
the short options (or written call options) they contributed.3
RTV and RSV withdrew from Petaluma on December 12, 2000.
Petaluma distributed cash and shares of Scient stock to RTV and
RSV in liquidation of their partnership interests. Pursuant to
section 732, RTV and RSV determined the adjusted bases in their
Scient stock according to the adjusted bases in their interests
in Petaluma immediately before the distribution. RTV and RSV
sold their Scient stock on December 26, 2000, and claimed losses
on their 2000 Federal income tax returns of about $17,776,360 and
$7,631,542, respectively. At the time of the filing of the
petition, Petaluma had no principal place of business and was
engaged in no business.
On April 2, 2001, Petaluma timely filed its Form 1065, U.S.
Return of Partnership Income, for the taxable year ending
December 31, 2000.
On July 28, 2005, respondent issued an FPAA to the tax
matters partner and the notice partners of Petaluma. On August
30, 2005, respondent issued a second FPAA to correct an error
regarding the taxable year to which the FPAA related. See
Petaluma FX Partners, LLC v. Commissioner, T.C. Memo. 2007-254.
With exceptions not relevant here, the adjustments made in the
3
Respondent does not dispute that RTV and RSV actually paid
the net premiums for these options.
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August 30, 2005, FPAA were identical to the adjustments made in
the July 28, 2005, FPAA.4 According to our holding in T.C. Memo.
2007-254, the FPAA issued on July 28, 2005, suffices to vest this
Court with jurisdiction for Petaluma’s tax year ending December
31, 2000. Further references herein to the FPAA are to the FPAA
issued on July 28, 2005.
In the FPAA, respondent made the following adjustments:
Item As Reported As Corrected
Capital contributions $478,800 -0-
Distributions--property 171,806 -0-
other than money
Outside partnership 24,943,505 -0-
basis
Distributions--money 206,076 -0-
Other income 107,242 -0-
Tax-exempt interest 547 -0-
income
Assets--cash 171,939 -0-
Liabilities and 6,158 -0-
capital--other
current liabilities
Partners’ capital 165,781 -0-
accounts
4
The corrected FPAA omitted adjustments to liabilities and
capital and assets/cash. Petitioner concedes that respondent’s
adjustments to these items are correct; therefore, our analysis
is the same regardless of which FPAA serves as the basis for our
jurisdiction.
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The FPAA also included the following statement:
Outside partnership basis and the penalties are
determined at the partnership level. The penalty will
be imposed on the partner level. The applicable
penalty sections are IRC 6662(a), 6662(b)(1),
6662(b)(2), 6662(b)(3), 6662(c), 6662(d), 6662(e) and
6662(h).
In addition, respondent made a number of determinations regarding
Petaluma and its partners under the title of “EXHIBIT A--
Explanation of Items” (the explanation of items). The
explanation of items is attached hereto as an appendix. The
explanation of items essentially provides the following
explanations for the adjustments to Petaluma’s partnership items:
(1) Petaluma was not a partnership as a matter of fact; (2) even
if Petaluma did exist as a partnership, it had no business
purpose other than tax avoidance, lacked economic substance,
constituted an economic sham, and was abusive under section
1.701-2, Income Tax Regs.; therefore, the transactions Petaluma
entered into should be treated as having been entered into
directly by the partners; and (3) neither Petaluma nor its
partners entered into the options positions or purchased the
foreign currency or stock with a profit motive for purposes of
section 165(c)(2). The explanation of items also provides
several alternative reasons for reducing the partners’ adjusted
bases in Petaluma and determines that penalties under section
6662 are applicable. On December 30, 2005, RSV, as a partner
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other than the tax matters partner of Petaluma, filed a petition
seeking review of the adjustments set forth in the FPAA.
On May 22, 2007, the parties filed a stipulation of settled
issues (stipulation). Petitioner stipulated that the following
partnership items should be adjusted according to the FPAA:
Other income, tax-exempt interest income, distributions--money,
distributions–-property other than money, capital contributions,
assets-–cash, liabilities and capital-–other current liabilities,
and partner’s capital accounts. Petitioner further stipulated
that his position is that the Court lacks jurisdiction to
consider the remaining issues raised in the FPAA, which include
the partners’ aggregate adjusted basis in the partnership (or
outside basis) and the determinations in the explanation of
items, including the penalties. However, petitioner also
stipulated that he would not contest any issues raised by the
FPAA over which the Court has jurisdiction except for the issue
of whether the valuation misstatement penalties apply.
Respondent filed a motion for summary judgment asserting
that the Court has jurisdiction over the remaining issues raised
by the FPAA because they all relate to partnership items and that
a decision should be entered in favor of respondent on the
remaining issues.
Petitioner filed a cross-motion for summary judgment arguing
that he has stipulated all of the partnership items adjusted in
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the FPAA and is entitled to summary judgment because all of the
remaining issues relate to nonpartnership items over which the
Court lacks jurisdiction under section 6226(f).5 In the
alternative, petitioner argues that the valuation misstatement
penalties imposed under section 6662(a), (b)(3), (e), and (h) are
inapplicable as a matter of law because the penalties do not
relate to an error in “valuation” but relate to respondent’s
determination that Petaluma and/or the transactions it
purportedly entered into should be disregarded.
Discussion
Summary judgment is intended to expedite litigation and
avoid unnecessary and expensive trials. Fla. Peach Corp. v.
Commissioner, 90 T.C. 678, 681 (1988). Summary judgment may be
granted where there is no genuine issue of any material fact and
a decision may be rendered as a matter of law. Rule 121(a) and
(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992),
affd. 17 F.3d 965 (7th Cir. 1994).
The parties agree that this case is ripe for summary
judgment because both parties raise only questions of law.
Petitioner stipulated: “if the Court determines that it has
jurisdiction in this case, petitioner does not intend to contest
5
Petitioner did not file a motion for dismissal because
sec. 6226(h) provides that a “decision of the court dismissing
the action shall be considered as its decision that the notice of
final partnership administrative adjustment is correct”.
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any of the issues raised in the FPAA other than the issue of
whether the valuation misstatement penalty would apply in this
case”. When a party explicitly states that he does not intend to
contest an issue, we have found it appropriate to deem the issue
conceded and not require the other party to prove the issue
affirmatively. Tan Xuan Bui v. Commissioner, T.C. Memo. 2007-
104; DeCaprio v. Commissioner, T.C. Memo. 1996-367. Furthermore,
stipulations are treated as conclusive and binding admissions by
the parties unless otherwise permitted by the Court. Rule 91(e);
Stamos v. Commissioner, 87 T.C. 1451, 1454-1455 (1986).
Accordingly, with the exception of the determinations of the
valuation penalties, if we find that we have jurisdiction over a
determination made in the FPAA, we shall treat the issue as
conceded by petitioner, grant respondent’s motion for summary
judgment on the issue, and deny petitioner’s cross-motion for
summary judgment on the issue.
Petitioner’s primary argument is that all of the adjustments
and determinations in the FPAA that petitioner has not conceded
are adjustments to the partners’ outside bases or are otherwise
nonpartnership items that are outside the Court’s jurisdiction
under section 6226(f). Specifically, petitioner argues that the
determinations that Petaluma should be disregarded for tax
purposes, that the partners’ aggregate outside partnership basis
is zero, and that the penalties apply are either nonpartnership
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items or not “items” at all. In the alternative, petitioner
argues that valuation misstatement penalties are not applicable
here.
I. TEFRA Procedures and Partnership Items
Partnerships do not pay Federal income taxes, but they are
required to file annual information returns reporting the
partners’ distributive shares of tax items. Secs. 701, 6031.
The individual partners then report their distributive shares of
the tax items on their Federal income tax returns. Secs. 701-
704.
To remove the substantial administrative burden occasioned
by duplicative audits and litigation and to provide consistent
treatment of partnership tax items among partners in the same
partnership, Congress enacted the unified audit and litigation
procedures of the Tax Equity and Fiscal Responsibility Act of
1982 (TEFRA), Pub. L. 97-248, sec. 401, 96 Stat. 648. See
Randell v. United States, 64 F.3d 101, 103 (2d Cir. 1995); H.
Conf. Rept. 97-760, at 599-600 (1982), 1982-2 C.B. 600, 662-663.
Under TEFRA, all partnership items are determined in a
single partnership-level proceeding. Sec. 6226; see also Randell
v. United States, supra at 103. The determination of partnership
items in a partnership-level proceeding is binding on the
partners and may not be challenged in a subsequent partner-level
proceeding. See secs. 6230(c)(4), 7422(h). This prevents the
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courts from relitigating the same issues with each of the
partners.
After the final partnership-level adjustments have been
made, further partner-level actions may be taken to bring the
partners’ returns into conformity with the determinations made at
the partnership level or to address issues that are specific to
the partners. If a computational adjustment can be made without
making any additional partner-level determinations, the
Commissioner directly assesses the changes in the partner’s tax
liability as a computational adjustment without issuing a notice
of deficiency. Sec. 6231(a)(6), (c); N.C.F. Energy Partners v.
Commissioner, 89 T.C. 741, 744 (1987); sec. 301.6231(a)(6)-1T(a),
Temporary Proced. & Admin. Regs., 64 Fed. Reg. 3840 (Jan. 26,
1999). If the partner believes that the computational adjustment
was erroneous, he may bring a claim for refund after payment.
Sec. 6230(c). If a partner has an increased liability stemming
from an affected item or a computational adjustment that requires
a factual determination at the partner level, the normal
deficiency procedures outlined in sections 6212 and 6213 apply.
Sec. 6230(a); sec. 301.6231(a)(6)-1T(a)(2), Temporary Proced. &
Admin. Regs., supra.
In partnership-level proceedings such as the case before us,
the Court’s jurisdiction is limited by section 6226(f):
SEC. 6226(f). Scope of Judicial Review.--A court
with which a petition is filed in accordance with this
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section shall have jurisdiction to determine all
partnership items of the partnership for the
partnership taxable year to which the notice of final
partnership administrative adjustment relates, the
proper allocation of such items among the partners, and
the applicability of any penalty, addition to tax, or
additional amount which relates to an adjustment to a
partnership item. [Emphasis added.]
Section 6231(a) defines the terms “partnership item”,
“nonpartnership item”, and “affected item”:
(3) Partnership item.--The term “partnership item”
means, with respect to a partnership, any item required
to be taken into account for the partnership's taxable
year under any provision of subtitle A to the extent
regulations prescribed by the Secretary provide that,
for purposes of this subtitle, such item is more
appropriately determined at the partnership level than
at the partner level.
(4) Nonpartnership item.--The term “nonpartnership
item” means an item which is (or is treated as) not a
partnership item.
(5) Affected item.--The term “affected item” means
any item to the extent such item is affected by a
partnership item.
An “affected item” is by definition not a “partnership item”.
Ginsburg v. Commissioner, 127 T.C. 75, 79 (2006); see also Dial
USA, Inc. v. Commissioner, 95 T.C. 1, 5 (1990).
II. The Explanation of Items
Petitioner argues that the Court lacks jurisdiction over all
of the determinations in the explanation of items. Petitioner
argues that if the Court affirms the various alternative
arguments in the explanation of items, this will amount to an
advisory opinion because petitioner has stipulated all of the
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adjustments to partnership items. See Greene-Thapedi v.
Commissioner, 126 T.C. 1, 13 (2006); LTV Corp. v. Commissioner,
64 T.C. 589 (1975).
However, partnership items also affect affected items, which
are by definition nonpartnership items and therefore would not be
redetermined by the Court in this partnership-level proceeding.
See Ginsburg v. Commissioner, supra at 79; Dial USA, Inc. v.
Commissioner, supra at 5; sec. 301.6231(a)(3)-1, Proced. & Admin.
Regs.; sec. 301.6231(a)(5)-1T, Temporary Proced. & Admin. Regs.,
52 Fed. Reg. 6790 (Mar. 5, 1987). Because partnership items
include not only the figures reported on a partnership’s return
but also determinations that may affect nonpartnership items, it
is essential to determine all partnership items at the
partnership level.
III. Whether Petaluma and Its Transactions Should Be
Disregarded for Tax Purposes
The first determination in the explanation of items is that
Petaluma was not a partnership in fact. The second and third
determinations in the explanation of items are to the effect that
if Petaluma was otherwise a partnership, it had no business
purpose other than tax avoidance, lacked economic substance,
constituted an economic sham for Federal income tax purposes, and
was abusive under section 1.701-2, Income Tax Regs. As a
consequence, the FPAA determines that Petaluma and all of the
transactions it purportedly engaged in should be disregarded and
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that the transactions that Petaluma engaged in should be treated
as having been engaged in directly by the partners. Because all
of these determinations have the same consequence, that Petaluma
should be disregarded for tax purposes, we address them together.
Section 6233 provides that if a partnership return is filed
for a year but it is determined that no partnership exists, the
subchapter that governs the procedure for taxing partnership
items still applies to the extent provided in the regulations.
The regulations provide that the TEFRA provisions will generally
continue to apply if a purported partnership files a partnership
return. Sec. 301.6233-1T(a), Temporary Proced. & Admin. Regs.,
52 Fed. Reg. 6795 (Mar. 5, 1987). The regulations further
provide that in a partnership-level proceeding the Court may
determine whether a “partnership” existed during the year. Id.Therefore, because Petaluma filed a partnership return for 2000,
under section 6233 and the regulations promulgated thereunder the
Court has jurisdiction to determine whether to recognize Petaluma
as a partnership for tax purposes. See also Andantech L.L.C. v.
Commissioner, 331 F.3d 972, 980-981 (D.C. Cir. 2003), affg. in
part and remanding in part T.C. Memo. 2002-97.
Furthermore, the determination of whether a partnership
should be disregarded for tax purposes under a legal doctrine
such as sham or economic substance is a partnership item.
Petitioner argues that the issue of whether Petaluma should be
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disregarded for tax purposes as a sham or for lack of economic
substance is not a partnership item because: (1) It is not an
“item”, (2) it is not a determination Petaluma was required to
make under subtitle A, and (3) the regulations do not list the
question of whether a partnership should be disregarded for tax
purposes under one of these doctrines as a partnership item.
A. Whether a Determination Must Be an “Item”
Petitioner argues that when used in the Code in connection
with defining tax consequences of various transactions, the term
“item” means an item of income, deduction, credit, gain, loss, or
basis, or a similar accounting entry. Under petitioner’s theory,
the determinations made in the explanation of items are not
“items” themselves but merely explanations of the numerical
adjustments made in the FPAA.
In RJT Inv. X v. Commissioner, 491 F.3d 732, 735 (8th Cir.
2007), the Court of Appeals reasoned that a “partnership item” is
defined as: (1) Any item required to be taken into account for
the partnership’s taxable year under a provision of subtitle A,
(2) to the extent the regulations prescribe that the item is more
appropriately determined at the partnership level. The court
concluded that determinations based on judicial doctrines such as
sham may be partnership items. Id. at 735-738; see also
Andantech L.L.C. v. Commissioner, supra at 980-982 (affirming
this Court’s decision in a partnership-level proceeding that the
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partnership should be disregarded for tax purposes). We agree
that partnership items may include determinations of whether a
partnership should be disregarded for tax purposes as a sham or
for lack of economic substance. Therefore we disagree that the
term “partnership item” is defined in the narrow sense that
petitioner advocates.
B. Whether the Determination To Disregard Petaluma Is
Required To Be Taken Into Account for Petaluma’s Taxable
Year Under a Provision of Subtitle A
Petitioner argues that judicial doctrines such as sham or
lack of economic substance that address the validity of a
partnership are not found in subtitle A, in any part of the Code
related to partnerships, or on Form 1065; therefore, a
determination that Petaluma is a sham and/or lacks economic
substance cannot be a partnership item under section 6231(a)(3).
Respondent argues that the definition of a “partnership
item” is not so limited. Respondent argues that if a partnership
is a sham, lacks economic substance, or was formed for tax
avoidance purposes, the partnership and/or its transactions are
disregarded for tax purposes. See Andantech L.L.C. v.
Commissioner, T.C. Memo. 2002-97. Consequently, the amount of
the partnership’s income, credit, gain, loss, deduction, and
similar items would be reduced to zero, and these items are
required to be taken into account under subtitle A.
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While petitioner has stipulated or will not contest most of
the adjustments in the FPAA, this does not affect the need to
determine whether Petaluma was a sham or lacked economic
substance in order to properly account for various tax items
under subtitle A. Petitioner may not eliminate our jurisdiction
over the determinations in the explanation of items by conceding
the adjustments to one or more of the partnership items. See LTV
Corp. v. Commissioner, 64 T.C. at 591. Furthermore, as discussed
above, a determination whether Petaluma was a valid partnership
is not mooted by petitioner’s stipulations because a
determination of whether Petaluma was a valid partnership may
also affect any number of affected items.
RJT Inv. X v. Commissioner, supra, supports respondent’s
position that the determination of whether a partnership should
be disregarded for tax purposes is a partnership item. The court
reasoned that the validity of a partnership–-in particular, its
status as a sham--is a matter that is required to be taken into
account under subtitle A because it directly affects many of the
components of the partnership’s and partners’ tax reporting:
When filling out individual tax returns, the very
process of calculating an outside basis, reporting a
sales price, and claiming a capital loss following a
partnership liquidation presupposes that the
partnership was valid.
Id. at 736. Therefore, because the validity of a partnership
affects tax items that are required to be taken into account
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under subtitle A, the validity of a partnership is also a
determination the partnership is required to make.
Petitioner argues that RJT Investments X is distinguishable
because in RJT Investments X the record included comprehensive
facts sufficient for the court to conclude, as a matter of fact,
that the partnership was a sham. Petitioner argues that the
court’s treatment of that matter as a partnership item was merely
dictum rather than a holding because the factual findings were
sufficient to eliminate the partners’ outside bases.
Petitioner is incorrect. As in this case, the taxpayers in
RJT Investments X raised only jurisdictional arguments on appeal
and were deemed to have waived any challenges to the sufficiency
of the evidence. Id. at 735, 738 n.9. The legal issue in RJT
Investments X is the same question that we must decide, and we
are persuaded by the decision of the Court of Appeals.
Petitioner also argues that the explanation of items
contains various alternative arguments and nothing in subtitle A
requires a partnership to affirmatively rebut the myriad
potential arguments that the Commissioner might use to attack the
validity of a partnership and its transactions. However,
petitioner points to no authority, and we know of none, that
prohibits an FPAA from asserting alternative arguments for
adjusting partnership items.
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For the reasons provided in RJT Investments X, we agree with
respondent that whether Petaluma is a sham, lacks economic
substance, or otherwise should be disregarded for tax purposes is
required to be taken into account under subtitle A. Therefore
this requirement is satisfied.
C. Whether the Regulations Prescribe That the Item Is
More Appropriately Determined at the Partnership
Level
Section 301.6231(a)(3)-1(a), Proced. & Admin. Regs., lists a
number of items that constitute “partnership items” but does not
explicitly list judicial concepts such as “sham” or “economic
substance”. However, section 301.6231(a)(3)-1(b), Proced. &
Admin. Regs., provides that the term “partnership item” also
includes “the accounting practices and the legal and factual
determinations that underlie the determination of the amount,
timing, and characterization of items of income, credit, gain,
loss, deduction, etc.” Because the determination of whether a
partnership is a sham or lacks economic substance underlies all
of the purported partnership’s tax items, it fits squarely within
the regulation. See Gregory v. Helvering, 293 U.S. 465 (1935);
Andantech L.L.C. v. Commissioner, T.C. Memo. 2002-97.
Petitioner argues that notwithstanding section
301.6231(a)(3)-1(b), Proced. & Admin. Regs., the validity of
Petaluma is more appropriately determined at the partner level
because the decision of whether a partnership should be respected
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for tax purposes is based on the totality of the facts and
circumstances surrounding the transaction. See Falsetti v.
Commissioner, 85 T.C. 332, 348 (1985); Salina Pship. L.P. v.
Commissioner, T.C. Memo. 2000-352. Petitioner emphasizes that
whether economic substance or related judicial doctrines should
apply “involves an intensely factual inquiry.” Andantech L.L.C.
v. Commissioner, T.C. Memo. 2002-97; see also Harris v.
Commissioner, 61 T.C. 770, 783 (1974). Therefore, petitioner
argues that because the “totality of the facts and circumstances”
necessarily includes some facts not available at the partnership
level, a determination of sham or lack of economic substance
cannot be a partnership item. In particular, petitioner argues
that the determination of whether a partnership is recognized for
substantive tax law purposes depends in part on the intent of the
partners. See Andantech L.L.C. v. Commissioner, 331 F.3d at 978.
Petitioner argues that any determination that requires a partner-
level analysis is a nonpartnership item. See N.C.F. Energy
Partners v. Commissioner, 89 T.C. at 744; Allen Family Foods,
Inc. v. Commissioner, T.C. Memo. 2000-327. Therefore, petitioner
argues that if the Court decides that the validity of Petaluma is
an “item”, it must be an affected item.
We first note that Andantech L.L.C. v. Commissioner, 331
F.3d 972 (D.C. Cir. 2003), upon which petitioner relies,
ultimately affirmed the Court’s finding in Andantech L.L.C. v.
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Commissioner, T.C. Memo. 2002-97, a partnership-level proceeding,
that the partnership at issue should be disregarded for tax
purposes. See also ASA Investerings Pship. v. Commissioner, T.C.
Memo. 1998-305, affd. 201 F.3d 505 (D.C. Cir. 2000). Petitioner
argues that Andantech L.L.C. v. Commissioner, 331 F.3d 972 (D.C.
Cir. 2003), and ASA Investerings Pship. v. Commissioner, 201 F.3d
505 (D.C. Cir. 2000), do not help respondent’s position because
the courts in those cases did not explicitly address whether
“sham” or “lack of economic substance” are partnership items but
affirmed the Tax Court’s decisions after making a factual
finding. We find that these cases do support respondent’s
position and implicit in the analysis of the Court’s decisions by
the Courts of Appeal is an analysis of jurisdiction.
We also disagree that the determination whether a
partnership is a sham or lacks economic substance is more
appropriately determined at the partner level. The validity of
the partnership affects all partners; therefore, partner-level
determinations of validity would defy TEFRA’s purpose of
preventing inconsistent treatment between partners. See RJT Inv.
X v. Commissioner, supra at 737. Furthermore, “Congress vested
in the Secretary of the Treasury, not in the federal courts, the
authority to weigh and decide what items are most suitably
ascertained at the partnership level.” Id. at 738 n.8. As
discussed above, we hold that section 301.6231(a)(3)-1(b),
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Proced. and Admin. Regs., encompasses determinations whether a
partnership is a sham or lacks economic substance.
For the reasons discussed above, we hold that the
determination whether Petaluma is a sham, lacks economic
substance, or otherwise should be disregarded for tax purposes is
a partnership item over which we have jurisdiction. Accordingly,
we shall grant respondent’s motion and deny petitioner’s cross-
motion for summary judgment on this issue.
IV. Outside Basis
The FPAA adjusted Petaluma’s aggregate outside basis from
$24,943,505 to zero. In the explanation of items, respondent
also determined that neither Petaluma nor its partners had
established that the partners had outside bases greater than
zero. Petitioner argues the Court lacks jurisdiction under
section 6226(f) to redetermine the partners’ outside bases in
Petaluma because in petitioner’s view, outside basis is not a
partnership item within the definition of section 6231(a)(3).
Respondent acknowledges that as a general matter the Court
lacks jurisdiction in a partnership-level proceeding to calculate
outside basis. A number of our opinions indicate that, with
certain exceptions not present in this case, a partnership is not
required to determine its partners’ outside bases, nor do the
regulations expressly provide that outside basis is more
appropriately determined at the partnership level than the
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partner level. See Domulewicz v. Commissioner, 129 T.C. 11, 20
(2007); Ginsburg v. Commissioner, 127 T.C. at 82; Dial USA, Inc.
v. Commissioner, 95 T.C. at 4;6 Gustin v. Commissioner, T.C.
Memo. 2002-64.7 However, respondent argues that the Court has
jurisdiction to determine that outside basis is zero if a
partnership is disregarded for tax purposes because there can be
no outside basis in a disregarded partnership.
Petitioner argues that outside basis cannot be a partnership
item regardless of whether the Court disregards a partnership for
tax purposes because partnerships are not required to take
outside basis into account under subtitle A. In Dakotah Hills
Offices Ltd. Pship. v. Commissioner, T.C. Memo. 1996-35, and
6
The subch. S audit and litigation provisions were repealed
by the Small Business Job Protection Act of 1996, Pub. L. 104-
188, sec. 1307(c)(1), 110 Stat. 1781, applicable to tax years
beginning after Dec. 31, 1996, id. sec. 1317(a), 110 Stat. 1787.
The definition of a subch. S item in former sec. 6245 was
parallel to the definition of a partnership item in sec.
6231(a)(3).
7
The Court noted in dicta in Countryside Ltd. Pship. v.
Commissioner, T.C. Memo. 2008-3 n.4, that under the circumstances
of that case (where the jurisdictional issue was raised by the
Commissioner, who had alleged in the FPAA gain to the partners in
excess of their zero basis, and where basis was entirely
determinable from partnership items), it had jurisdiction to
determine the partners’ outside bases during a partnership-level
proceeding.
Similarly, in Nussdorf v. Commissioner, 129 T.C. 30, 37, 44
(2007), the Court stated that determinations in notices of
deficiency issued to the partners were partnership items,
including a determination that one of the partners failed to
establish that it had an outside basis greater than zero.
However, this was consistent with the parties’ agreement.
- 24 -
Olsen-Smith, Ltd. v. Commissioner, T.C. Memo. 2005-174, we held
that the critical factor is whether the item is required to be
taken into account by the partnership. See also Dial USA, Inc.
v. Commissioner, supra at 4.
Furthermore, regardless of whether Petaluma should be
disregarded for tax purposes, petitioner points out that the
regulations do not definitively provide that outside basis is an
item that is more appropriately determined at the partnership
level than the partner level. See sec. 301.6231(a)(3)-1, Proced.
& Admin. Regs. By contrast, section 301.6231(a)(5)-1T(b),
Temporary Proced. & Admin. Regs., supra, provides that “A
partner’s basis in his interest in the partnership is an affected
item to the extent it is not a partnership item.” This
definition indicates that outside basis can be a partnership item
in certain circumstances, such as where a partnership makes an
election under section 754 and must calculate a partner’s outside
basis to determine its own basis in its assets under section
734(b), see sec. 301.6231(a)(3)-1(a)(3), Proced. & Admin. Regs.,
or where one partnership owns an interest in a second partnership
and must determine its outside basis in the second partnership.
However, neither situation is present here.
This case presents a situation that is different from one
where the calculation of a partner’s outside basis requires
determinations to be made at the partner level. If there is no
- 25 -
partnership, there will be no need to make further factual
determinations at the partner level. If a purported partner is
determined not to have had an interest in a partnership, no facts
available at the partner level will establish that the partner
had an outside basis in the partnership.
The regulations indicate that in a situation where no
partner-level determinations are necessary to determine outside
basis, this determination may be a partnership item. Section
301.6231(a)(3)-1(c)(2) and (3), Proced. & Admin. Regs., provides
that partnership items include determinations that relate to
contributions and distributions to the extent that those
determinations do not require information that is outside the
Court’s jurisdiction. Allen Family Foods, Inc. v. Commissioner,
T.C. Memo. 2000-327. Outside basis is related to a partner’s
contributions and share of distributions. Secs. 722, 733. If a
partnership is disregarded for tax purposes or a partner’s
participation in the partnership is disregarded, the Court may
determine that the partner’s outside basis is zero without
requiring a partner-level determination because there can be no
adjusted basis in a disregarded partnership. The Court will not
turn a blind eye to the fact that a partner has no outside basis
when this is a conclusion that stems directly from the Court’s
determination that a partnership or a partner’s participation in
the partnership should be disregarded.
- 26 -
As discussed above, we have jurisdiction to determine
whether Petaluma should be disregarded for tax purposes. Because
petitioner will not contest this determination other than on
jurisdictional grounds, the effect of petitioner’s concession is
that Petaluma will be disregarded for tax purposes. There can be
no basis in a disregarded entity. If the partners have no
outside bases, we may treat their outside bases as zero. See
Rybak v. Commissioner, 91 T.C. 524, 566-567 (1988); Zfass v.
Commissioner, T.C. Memo. 1996-167, affd. 118 F.3d 184 (4th Cir.
1997). Accordingly, we shall grant respondent’s motion and deny
petitioner’s cross-motion for summary judgment on this issue.
V. Penalties
A. Jurisdiction
The ninth determination states that the adjustments of
Petaluma’s partnership items are attributable to a tax shelter
for which no substantial authority or reasonable basis has been
established. Furthermore, it determines that all of the
underpayments of tax resulting from those adjustments of
partnership items are attributable at a minimum to: (1) Gross or
substantial valuation misstatements penalized under section
6662(a), (b)(3), (e), and (h); (2) negligence or disregard of
rules or regulations penalized under section 6662(a), (b)(1), and
(c); or (3) substantial understatements of income tax penalized
under section 6662(a), (b)(2), and (d).
- 27 -
A taxpayer is liable for an accuracy-related penalty of 20
percent of any part of an underpayment attributable to, in
pertinent part, a substantial valuation misstatement, negligence
or disregard of rules or regulations, or a substantial
understatement of income tax. Sec. 6662(a) and (b)(1), (2), and
(3).
As part of the Taxpayer Relief Act of 1997, Pub. L. 105-34,
sec. 1238(a), 111 Stat. 1026, Congress amended sections 6221 and
6226(f) to provide that the applicability of penalties that
relate to adjustments to partnership items is determined at the
partnership level. Before the amendment, the applicability of
all penalties was determined at the partner level because
penalties are affected items. See N.C.F. Energy Partners v.
Commissioner, 89 T.C. 741 (1987).
Section 6221 now provides: “the applicability of any
penalty, addition to tax, or additional amount which relates to
an adjustment to a partnership item * * * shall be determined at
the partnership level.”
Petitioner acknowledges that under section 6226(f) the Court
has jurisdiction to determine the “applicability of any penalty,
addition to tax, or additional amount which relates to an
adjustment to a partnership item.” (Emphasis added.) However,
petitioner argues that the penalties determined in the FPAA are
attributable to adjustments to affected items, not partnership
- 28 -
items, and are accordingly outside the Court’s jurisdiction in
this partnership-level proceeding.
Respondent argues that even if the penalties are directly
attributable to adjustments to affected items, those items relate
to partnership items at least indirectly, and therefore they are
within the Court’s jurisdiction. For example, if Petaluma is
disregarded for tax purposes, RTV and RSV will be found to have
underpayments due to the sale of Scient stock that took basis by
reference to a partnership disregarded for tax purposes.
Petitioner counters that while the penalties may indirectly
relate to partnership items, the statute provides the Court with
jurisdiction only over penalties that directly relate to
partnership items.
Congress expanded the Court’s jurisdiction in partnership-
level proceedings when it amended sections 6221 and 6226(f), and
the legislative history accompanying those amendments suggests
that Congress intended the Court’s jurisdiction over penalties to
be interpreted broadly:
Reasons for Change
Many penalties are based upon the conduct of the
taxpayer. With respect to partnerships, the relevant
conduct often occurs at the partnership level. In
addition, applying penalties at the partner level
through the deficiency procedures following the
conclusion of the unified proceeding at the partnership
level increases the administrative burden on the IRS
and can significantly increase the Tax Court's
inventory.
- 29 -
Explanation of Provision
The bill provides that the partnership-level
proceeding is to include a determination of the
applicability of penalties at the partnership level.
However, the provision allows partners to raise any
partner-level defenses in a refund forum. [H. Rept.
105-148, at 594 (1997), 1997-4 C.B. (Vol. 1) 319, 916;
emphasis added.]
The conference report suggests that the words “relates to” in
sections 6221 and 6226(f) should be read expansively.
We applied the amended versions of sections 6221 and 6226(f)
in Fears v. Commissioner, 129 T.C. 8, 10 (2007), Domulewicz v.
Commissioner, 129 T.C. at 23, and Bedrosian v. Commissioner, T.C.
Memo. 2007-376. These cases also indicate that the words
“relates to” should be read expansively. We hold that the FPAA
determined that the accuracy-related penalties apply as a result
of the determination that Petaluma should be disregarded for tax
purposes and this relation suffices to vest the Court with
jurisdiction over the penalties.8
B. The Valuation Misstatement Penalty
A “substantial valuation misstatement” occurs if the value
or the adjusted basis of any property claimed on any return of
tax is 200 percent or more of the correct amount. Sec.
8
In this case we do not make partner-level determinations
for purposes of deciding the applicability of penalties at the
partnership level. We do not address in this case whether we
have jurisdiction in a partnership-level proceeding to determine
affected items if the resolution of such items is required to
finally determine the amount of a penalty.
- 30 -
6662(e)(1)(A). The penalty is increased to 40 percent if the
underpayment of tax is the result of a gross valuation
misstatement, which is the valuation misstatement determined
under section 6662(e) after substituting “400 percent” for “200
percent”. Sec. 6662(h)(2)(A).
Respondent argues that while the amount of the penalty must
be determined at the partner level, the determination of whether
there is a substantial valuation misstatement should be
determined at the partnership level. Respondent argues that the
valuation misstatement penalty applies in this case because the
determinations made in the FPAA regarding Petaluma’s partnership
items cause the bases of its partners’ interests in the
partnership to be reduced to zero instead of $25 million
(collectively) as claimed. While the underpayments of tax the
partners were required to show on their returns were due to the
overstatement of each partner’s Scient stock, under section
732(b) the partners determined their adjusted bases in the Scient
stock by reference to their outside bases in Petaluma before its
liquidation.
As discussed above, if a partnership is disregarded for tax
purposes the Court has jurisdiction to treat the partners’
outside bases as zero. If a property has a basis of zero, any
basis claimed above that will be a valuation overstatement and
the penalty will apply. Rybak v. Commissioner, 91 T.C. at 566-
- 31 -
567; Zfass v. Commissioner, T.C. Memo. 1996-167; Illes v.
Commissioner, T.C. Memo. 1991-449, affd. 982 F.2d 163 (6th Cir.
1992).
Petitioner argues that if the Court has jurisdiction over
the accuracy-related penalties under section 6662, respondent has
not met his burden of production under section 7491(c).
Petitioner stipulated that he is contesting only the valuation
misstatement penalty, and we treat this stipulation as binding on
petitioner. See Rule 91(e); Stamos v. Commissioner, 87 T.C. at
1454-1455. Therefore, we treat petitioner’s argument as only
relating to the valuation misstatement penalties and not
challenging the accuracy-related penalty on the bases of
negligence and substantial understatement of income tax.
Petitioner argues that respondent has not satisfied his burden of
production because he is asserting the penalties against the
individual partners, not the partnership.
Respondent argues that section 7491(c) does not apply
because that section applies only in proceedings “with respect to
the liability of any individual for any penalty”, and Petaluma is
not an individual. (Emphasis added.) See Santa Monica Pictures,
LLC v. Commissioner, T.C. Memo. 2005-104. Even if section
7491(c) does apply, we find that respondent has satisfied his
burden of production. As discussed above, petitioner does not
dispute, except on jurisdictional grounds, that Petaluma lacked
- 32 -
economic substance and the partners’ outside bases are zero.
Therefore, we find that respondent has met the threshold
requirement to support his determination that the gross valuation
misstatement penalty applies.
Petitioner next argues that the valuation misstatement
penalties are inapplicable as a matter of law. According to
petitioner, the overstatement of the partners’ outside bases
resulted from respondent’s determinations that Petaluma and/or
the transactions it purportedly entered into should be
disregarded, not from an erroneous valuation. Petitioner argues
that this penalty was not aimed at, and should not be imposed on,
incorrect application or interpretation of the law. As support,
petitioner points to a statement in the report prepared by the
staff of the Joint Committee on Taxation, which accompanied the
enactment of section 6659, the predecessor to section 6662(b)(3):
“The Congress believed that a specific penalty was needed to deal
with various problems related to the valuation of property.”
Staff of Joint Comm. on Taxation, General Explanation of the
Economic Recovery Tax Act of 1981, at 332 (J. Comm. Print 1981).
Petitioner argues that we should follow the approach taken
by the Court of Appeals for the Fifth Circuit, that the valuation
overstatement penalty (the predecessor to the valuation
misstatement penalty) is not appropriate when the overstatement
of basis results from a transaction that has been disregarded in
- 33 -
its entirety. See Heasley v. Commissioner, 902 F.2d 380, 383
(5th Cir. 1990), revg. T.C. Memo. 1988-408.
Respondent acknowledges that the Court of Appeals for the
Fifth Circuit has taken the position that valuation overstatement
penalties do not apply when the overstatement stems from
disregard of a transaction. However, respondent argues that we
should instead follow the approach we took in Zfass v.
Commissioner, supra, that “When a transaction lacks economic
substance, the correct basis is zero; any amount claimed is a
valuation overstatement” that may be subject to a penalty for a
valuation overstatement.
Under Golsen v. Commissioner, 54 T.C. 742, 757 (1970), affd.
445 F.2d 985 (10th Cir. 1971), the Court will follow the decision
of the Court of Appeals to which a case is appealable if the
Court of Appeals has already decided the issue. However, we will
give effect to our own views in cases appealable to courts that
have not yet decided the issue. Id. Because Petaluma had no
principal place of business at the time the petition was filed,
this case may be appealable to the Court of Appeals for the
District of Columbia Circuit. Sec. 7482(b)(1). The Court of
Appeals for the District of Columbia Circuit has not yet ruled on
the issue of whether the valuation misstatement penalty applies
to underpayments attributable to overstated bases in property
- 34 -
involved in transactions that are shams and/or lack economic
substance.
The Courts of Appeals for the Second, Third, Fourth, Sixth,
and Eighth Circuits have affirmed this Court’s imposition of the
valuation overstatement or misstatement penalty where the
underpayment results from a sham transaction lacking economic
substance. Merino v. Commissioner, 196 F.3d 147, 158-159 (3d
Cir. 1999), affg. T.C. Memo. 1997-385; Zfass v. Commissioner, 118
F.3d at 191; Illes v. Commissioner, 982 F.2d at 167; Gilman v.
Commissioner, 933 F.2d 143, 151 (2d Cir. 1991), affg. T.C. Memo.
1989-684; Massengill v. Commissioner, 876 F.2d 616, 619-620 (8th
Cir. 1989), affg. T.C. Memo. 1988-427. Respondent argues that
this approach is consistent with section 1.6662-5(g), Income Tax
Regs., which provides:
(g) Property with a value or adjusted basis of
zero.--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.
In keeping with the decisions of the majority of the Courts
of Appeals and our own prior decisions, we conclude that the
gross valuation penalty applies when the adjusted basis of
property is reduced to zero because a transaction was disregarded
as a sham or lacking economic substance and the taxpayer claims
an adjusted basis in the property of a greater amount.
- 35 -
Petitioner next argues that the valuation penalty is not
appropriate when there is some other ground for disallowing the
entire portion of the disputed deduction and that this rule
applies here. See Gainer v. Commissioner, 893 F.2d 225 (9th Cir.
1990), affg. T.C. Memo. 1988-416. Petitioner argues that the
facts of this case are analogous to those in Weiner v. United
States, 389 F.3d 152 (5th Cir. 2004). In Weiner, the taxpayers
challenged the interest charged against them for “tax-motivated
transactions” pursuant to section 6621(c) (now repealed). Id. at
153. Section 6621(c) imposed an interest rate of 120 percent of
the statutory rate on “any substantial underpayment attributable
to tax motivated transactions”. Included in the definition of
“tax motivated transaction” in section 6621(c)(3)(A)(v) was any
“sham or fraudulent transaction”. In the FPAAs, the Internal
Revenue Service (IRS) asserted several bases for disallowing
certain deductions, one of which was “sham or fraudulent
transaction”. Id. at 159-160. However, because the taxpayers
settled with the IRS, there was never any need for a court to
examine the IRS’s alternative bases for disallowance or make
factual findings about their application. Id. at 160. The court
concluded that because the FPAA listed several independent
reasons for disallowing the taxpayers’ deductions, some of which
were not related to tax-motivated transactions, there was no way
to determine without additional superfluous litigation whether
- 36 -
the taxpayers’ underpayments were attributable to a tax-motivated
transaction. Id. at 162.
The court in Weiner relied partially on Todd v.
Commissioner, 862 F.2d 540 (5th Cir. 1988), affg. 89 T.C. 912(1987). In Todd v. Commissioner, supra at 541, the dispute was
over the application of the valuation overstatement penalty under
former section 6659(a). The court found that the taxpayers’
liability was attributable to the fact that because they did not
place their property in service before a certain date, the
valuation of the property had no impact on the tax actually owed.
Id. at 543.
Petitioner argues that if we find that all of the
determinations in the explanation of items are partnership items,
it will be impossible to determine which of the determinations
provide the grounds for imposing the valuation misstatement
penalty. While a determination that Petaluma was a sham and/or
lacked economic substance would cause the partners’ outside bases
in Petaluma to be reduced to zero, many of the other
determinations would have the same effect. According to
petitioner, because it is initially impossible to tell under
respondent’s theory why the partners’ outside bases are being
disallowed, under Weiner and Todd, the Court will not be able to
conclude that the penalty should be imposed because of a gross
valuation misstatement.
- 37 -
Respondent acknowledges that the Court does not apply the
valuation misstatement penalty in cases where the deduction or
credit is disallowed for reasons other than the fact that the
value or basis of the property was inflated. Todd v.
Commissioner, 89 T.C. 912 (1987); Gainer v. Commissioner, T.C.
Memo. 1988-416. However, respondent argues that unlike the
situations in Todd and Gainer, in this case respondent’s
alternative arguments all affect the partners’ bases in the
partnership. Under any of respondent’s alternative arguments the
penalty is imposed on the same determination--the misstatement of
the partners’ outside bases. We agree with respondent that Todd
and Gainer are for that reason distinguishable from this case.
Petitioner finally argues that the valuation misstatement
penalty is improper because the factual record does not support
respondent’s arguments that Petaluma and the transactions in
which Petaluma and its partners engaged were shams and/or lacked
economic substance. To the contrary, petitioner argues that the
exhibits respondent submitted, particularly a memorandum
describing the offering of interests in Petaluma to potential
investors, prove that Petaluma was a valid partnership that
engaged in real transactions.
Petitioner argues that while he stipulated that he would
challenge jurisdiction only over the disputed items and the
propriety of imposing the valuation penalty, he has not conceded
- 38 -
the valuation penalty just because the FPAA determines that
Petaluma was a sham and/or lacked economic substance. Petitioner
preserved the right to argue that sham and lack of economic
substance are not partnership items and argues that this right
necessarily includes the right to argue whatever is necessary to
mount that challenge. Petitioner argues that it is proper to
argue that the factual record supports a finding that Petaluma
engaged in real transactions with a real business purpose and,
therefore, respondent’s sham or lack of economic substance
argument is not supported by the record.
We agree that petitioner preserved the right to argue that
sham and lack of economic substance are not partnership items.
However, this is not the same as preserving the right to
challenge on factual grounds respondent’s position that Petaluma
was a sham and lacked economic substance. Petitioner stipulated:
2. If the Court determines that it has
jurisdiction in this case, petitioner stipulates that
he does not intend to call any witnesses or offer any
evidence in this proceeding, or otherwise contest the
determinations made in the FPAA other than the
determination that the valuation misstatement penalty
imposed by I.R.C. § 6662(a), (b)(3), (e), and (h)
applies to any underpayment resulting from the
adjustments to partnership items.
We construe this stipulation to mean that petitioner did not
intend to challenge on factual grounds the FPAA’s determination
that Petaluma was a sham or otherwise lacked economic substance.
The stipulation means that petitioner did intend to challenge the
- 39 -
valuation misstatement penalty but only on the ground that it is
inapplicable to the adjustments to partnership items stated in
the FPAA, not on the ground that the adjustments to partnership
items were incorrect. It is incongruous that petitioner would
have stipulated that he would not call any witnesses or offer any
evidence if he intended to prove that Petaluma should be
respected for tax purposes in order to dispute the applicability
of the valuation misstatement penalties. This stipulation is
binding on the parties, and we do not find that justice requires
the Court to permit petitioner to qualify, change, or contradict
it. See Rule 91(e); Stamos v. Commissioner, 87 T.C. at 1454-
1455. Therefore, we hold that petitioner is precluded from
challenging this penalty on the merits during this proceeding.
However, if the partners have any personal defenses that they
wish to assert against the valuation misstatement penalty, they
may assert those defenses in a refund forum. Sec. 6230(c)(4).
On the basis of the foregoing, we shall grant respondent’s
motion for summary judgment and deny petitioner’s cross-motion
for summary judgment on this issue. Therefore, we need not
address whether the accuracy-related penalties for negligence or
understatement of income tax apply.
VI. The Remaining Determinations
As discussed above, petitioner argues that the Court lacks
jurisdiction over all of the determinations in the explanation of
- 40 -
items. However, with the exception of the determinations already
discussed, petitioner makes no specific arguments regarding
whether the remaining determinations are partnership items.
Furthermore, given our holdings that Petaluma should be
disregarded for tax purposes and the partners have no outside
bases, the remaining issues are moot and unnecessary to decide to
support a holding for respondent. Accordingly, we shall not
address whether the remaining determinations in the explanation
of items are partnership items.
Based on the foregoing,
An appropriate order and
decision will be entered.
- 41 -
APPENDIX
The explanation of items in Exhibit A to the FPAA issued to
petitioner made the following additional determinations:
1. It is determined that neither Petaluma FX Partners, LLC nor
its purported partners have established the existence of
Petaluma FX Partners, LLC as a partnership as a matter of
fact.
2. Even if Petaluma FX Partners, LLC existed as a partnership,
the purported partnership was formed and availed of solely
for purposes of tax avoidance by artificially overstating
basis in the partnership interests of its purported
partners.
The formation of Petaluma FX Partners, LLC, the acquisition
of any interest in the purported partnership by the
purported partner, the purchase of offsetting options, the
transfer of offsetting options to a partnership in return
for a partnership interest, the purchase of assets by the
partnership, and the distribution of those assets to the
purported partners in complete liquidation of the
partnership interests, and the subsequent sale of those
assets to generate a loss, had no business purpose other
than tax avoidance, lacked economic substance, and, in fact
and substance, constitutes an economic sham for federal
income tax purposes. Accordingly, the partnership and the
transactions described above shall be disregarded in full
and any purported losses resulting from these transactions
are not allowable as deductions for federal income tax
purposes.
3. It is determined that Petaluma FX Partners, LLC was a sham,
lacked economic substance and, under § 1.701-2 of the Income
Tax Regulations, was formed and availed of in connection
with a transaction or transactions in taxable year 2000 a
principal purpose of which was to reduce substantially the
present value of its partners’ aggregate federal tax
liability in a manner that is inconsistent with the intent
of Subchapter K of the Internal Revenue Code. It is
consequently determined that:
a. the Petaluma FX Partners, LLC is disregarded and
that all transactions engaged in by the purported
partnership are treated as engaged in directly by
its purported partners. This includes the
determination that the assets purportedly acquired
- 42 -
by Petaluma FX Partners, LLC, including but not
limited to foreign currency options, were acquired
directly by the purported partners.
b. the foreign currency option(s), purportedly
contributed to or assumed by Petaluma FX Partners,
LLC, are treated as never having been contributed
to or assumed by said partnership and any gains or
losses purportedly realized by Petaluma FX
Partners, LLC on the option(s) are treated as
having been realized by its partners.
c. the purported partners of Petaluma FX Partners,
LLC should be treated as not being partners in
Petaluma FX Partners, LLC.
d. contributions to Petaluma FX Partners, LLC will be
adjusted to reflect clearly the partnership’s or
purported partners’ income.
4. It is determined that the obligations under the short
positions (written call options) transferred to Petaluma FX
Partners, LLC constitute liabilities for purposes of
Treasury Regulation §1.752-6T, the assumption of which by
Petaluma FX Partners, LLC shall reduce the purported
partners’ bases in Petaluma FX Partners, LLC in the amounts
of $18,043,140 and $6,900,365 for Ronald Thomas Vanderbeek
and Ronald Scott Vanderbeek, respectively, but not below the
fair market value of the purported partnership interest.
5. It is determined that neither Petaluma FX Partners, LLC nor
its purported partners entered into the option(s) positions
or purchase [sic] the foreign currency or stock with a
profit motive for purposes of § 165(c)(2).
6. It is determined that, even if the foreign currency
option(s) are treated as having been contributed to Petaluma
FX Partners, LLC, the amount treated as contributed by the
partners under section 722 of the Internal Revenue Code is
reduced by the amounts received by the contributing partners
from the contemporaneous sales of the call option(s) to the
same counter-party. Thus, the basis of the contributed
option(s) is reduced, both in the hands of the contributing
partners and Petaluma FX Partners, LLC. Consequently, any
corresponding claimed increases in the outside basis in
Petaluma FX Partners, LLC resulting from the contributions
of the foreign currency option(s) are disallowed.
- 43 -
7. It is determined that the adjusted bases of the long call
positions (purchased call options), zero coupon notes, and
other contributions purportedly contributed by the partners
to Petaluma FX Partners, LLC has not been established under
I.R.C. § 723. It is consequently determined that the
partners of Petaluma FX Partners, LLC have not established
adjusted bases in their respective partnership interests in
an amount greater than zero (-0-).
8. It is further determined that, in the case of a sale,
exchange, or liquidation of Petaluma FX Partners, LLC
partners’ partnership interests, neither the purported
partnership nor its purported partners have established that
the bases of the partners’ partnership interests were
greater than zero for purposes of determining gain or loss
to such partners from the sale, exchange, or liquidation of
such partnership interest.
9. Accuracy-Related Penalties
It is determined that the adjustments of partnership items
of Petaluma FX Partners, LLC are attributable to a tax
shelter for which no substantial authority has been
established for the position taken, and for which there was
no showing of reasonable belief by the partnership or its
partners that the position taken was more likely than not
the correct treatment of the tax shelter and related
transactions. In addition, all of the underpayments of tax
resulting from those adjustments of partnership items are
attributable to, at a minimum, (1) substantial
understatements of income tax, (2) gross valuation
misstatement(s), or (3) negligence or disregarded [sic]
rules or regulations. There has not been a showing by the
partnership or any of its partners that there was reasonable
cause for any of the resulting underpayments, that the
partnership or any of its partners acted in good faith, or
that any other exceptions to the penalty apply. It is
therefore determined that, at a minimum, the accuracy-
related penalty under Section 6662(a) of the Internal
Revenue Code applies to all underpayments of tax
attributable to adjustments of partnership items of Petaluma
FX Partners, LLC. The penalty shall be imposed on the
components of underpayment as follows:
A. a 40 percent penalty shall be imposed on the portion of
any underpayment attributable to the gross valuation
misstatement as provided by Sections 6662(a),
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6662(b)(3), 6662(e), and 6662(h) of the Internal
Revenue Code.
B. a 20 percent penalty shall be imposed on the portion of
the underpayment attributable to negligence or
disregard of rules and regulations as provided by
Sections 6662(a), 6662(b)(1), 6662(c) of the Internal
Revenue Code.
C. a 20 percent penalty shall be imposed on the
underpayment attributable to the substantial
understatement of income tax as provided by sections
6662(a), 6662(b)(2), and 6662(d) of the Internal
Revenue Code.
D. a 20 percent penalty shall be imposed on the
underpayment attributable to the substantial valuation
misstatement as provided by Sections 6662(a),
6662(b)(3), and 6662(e) of the Internal Revenue Code.
It should not be inferred by the determination of the
Accuracy Related Penalty in this notice that fraud penalties
will not be sought on any portion of an underpayment
subsequently determined to be attributable to fraud or that
prosecution for criminal offenses will not be sought under
IRC § 7201, 7206 or other provisions of federal law if
determined to be appropriate.