Recent TEFRA Partnership Tax Litigation

Originally published by Matthew Roberts.

Stevens v. Comm’r, T.C. Memo. 2020-118 | August 6, 2020 | Halpern, J. | Dkt. Nos. 29815-13, 9539-15

• Opinion

Short Summary:  The IRS determined deficiencies for the taxpayers’ 2006, 2008, 2009, and 2010 tax years.  In addition, the IRS asserted additions to tax under Section 6651(a)(1) and accuracy-related penalties under Section 6662(a) for 2006, 2008, and 2010.  Moreover, because the taxpayers had not filed returns for 2005, 2007, 2011, and 2012, the IRS issued separate notices of deficiency to each taxpayer and also determined additions to tax under Section 6651(a)(1) and (2) and estimated additions to tax under Section 6654 for 2011 and 2012.

After the notices of deficiency were issued, the taxpayers submitted to the IRS signed and unsigned returns reflecting losses from TEFRA partnerships which effectively offset the deficiencies.  Prior to trial, the IRS moved to dismiss for lack of jurisdiction so much of each case as it related to partnership items, which was granted by the Tax Court.  Thereafter, the IRS provided recomputed deficiencies reflecting the dismissal of partnership items.  The taxpayers provided no evidence at trial challenging the adjustments underlying the deficiencies.

Key Issue:  To what extent can the Tax Court uphold the IRS’ recomputed deficiencies in light of the taxpayers’ claimed partnership loss deductions?

Primary Holdings: 

• (1) For the 2005 tax year, there is no issue for the Tax Court to decide because: (i) the IRS concedes there is no deficiency for such year; and (ii) the Tax Court granted the IRS’ motion for summary judgment in that the Tax Court lacks jurisdiction to order a refund or credit of any overpayment with respect to the 2005 tax year. (2) For the 2006 tax year, the IRS’ deficiency determination is upheld because:  (i) the partnerships at issue were “small partnerships” under Section 6231(a)(1)(B)(i); (ii) the “oversheltered” return rules under Section 6234 do not apply and therefore the Tax Court has jurisdiction to redetermine the deficiency determined by the IRS; and (iii) the taxpayers failed to substantiate the losses they reported from the partnerships. (3) For the 2007 and 2009 through 2012 tax years, the taxpayers have no deficiencies because:  (i) Section 6234 does not apply to these years; (ii) the notices of deficiency are valid under Dees v. Comm’r, 148 T.C. 1 (2017); (iii) the taxpayers’ filing of a petition in response to the notices of deficiency give the Tax Court jurisdiction to redetermine the deficiencies for such year; and (iv) the IRS’ adjustments to the taxpayers’ nonpartnership income for each year are offset by losses the taxpayers’ claim from partnerships the adjustment of which require partnership-level proceedings.  (4) For the 2008 tax year:  (i) the notice of deficiency for such year is treated as a notice of adjustment under Section 6234(a); (ii) the petition the taxpayers filed is treated as a petition for redetermination of adjustments to nonpartnership items under Section 6234(c); (iii) the taxpayers have not provided grounds for challenging the IRS’ determination of their capital gain from nonpartnership sources for 2008 or disallowance of their deduction for their loss from a partnership or their net farm rental loss for that year; and (iv) the Tax Court will issue a declaratory judgment under Section 6234(c) for 2008 upholding the IRS’ determinations concerning those items.

Key Points of Law:

• The privilege of filing a joint tax return depends on an election by the making of a return, as provided in Section 6013. Dritz v. Comm’r, T.C. Memo. 1969-175 (1969), aff’d, 427 F.2d 1176 (5^th 1970).
• TEFRA’s unified partnership audit and litigation rules require that the tax treatment of partnership items be determined in partnership-level proceedings that are generally binding on all partners. When applicable, the TEFRA partnership rules avoid the need for duplicative partner-level proceedings that might produce inconsistent results. Staff of J. Comm. on Taxation, General Explanation of the Revenue Provisions of the Tax Equity and Fiscal Responsibility Act of 1982, at 268 (J. Comm. Print 1982).  The rules generally require the IRS to conduct partnership-level proceedings to adjust partnership items before assessing tax against a partner as a result of the partnership adjustments.
• If a partner claims a large enough loss from a partnership subject to the TEFRA rules, that loss might not only shelter the income reported by the partner on his individual return but also absorb the effect of any adjustments the IRS seeks to make to the partner’s nonpartnership items, thereby preventing the determination of a deficiency. Congress enacted the “oversheltered return” rules of section 6234 to address that prospect.  Those rules apply when four conditions are met.
• First, the taxpayer must file an oversheltered return for a taxable year. 6234(a)(1).  A return is “oversheltered” if it shows no taxable income and a net loss from partnership items.  Sec. 6234(b).
• Second, the Commissioner must make a determination with respect to the treatment of items (other than partnership items) of the taxpayer for the taxable year in question. 6234(a)(2).
• Third, it must be the case that the Commissioner’s adjustments to nonpartnership items do not give rise to a deficiency. 6234(a)(3).
• And fourth, those adjustments would give rise to a deficiency if there were no net loss from partnership items.
• In sum, the rules apply when the effects of adjustments to nonpartnership items are absorbed by the taxpayer’s reported net partnership loss so that the adjustments do not produce a deficiency.
• When the oversheltered return rules apply, instead of issuing a notice of deficiency to the taxpayer, the Commissioner can “send a notice of adjustment” that reflects his determination regarding nonpartnership items. 6234(a).  The taxpayer can then file with the Tax Court a petition for redetermination of the adjustments.  Sec. 6234(c).  The filing of a petition gives the Tax Court jurisdiction to make a declaration with respect to all items (other than partnership items and affected items which require partner level determinations as described in section 6230(a)(2)(A)(i)) for the tax year to which the notice of adjustment relates.  Id.
• Congress enacted section 6234 to overrule the Tax Court’s decision in Munro v. Comm’r, 92 T.C. 71 (1989). Rept. No. 105-33, at 253 (1997).
• The Commissioner’s issuance of a notice of deficiency does not preclude the application of the oversheltered return rules for the year or years covered by the notice. See 6234(h)(2).
• Section 6231(a)(1)(B)(i) provides: “The term ‘partnership’ shall not include any partnership having 10 or fewer partners each of whom is an individual (other than a nonresident alien), a C corporation, or an estate of a deceased partner.”  That limitation “is applied to the number of natural persons, C corporations, and estates of deceased partners that were partners at any one time during the partnership taxable year.”  Reg. § 301.6231(a)(1)-1(a)(1).  Thus, a partnership qualifies for the exception for a tax year only if it meets the 10-or-fewer limitation throughout the year.
• There is a “longstanding principle that the party invoking this Court’s jurisdiction bears the burden of demonstrating that it exists.” Dees v. Comm’r, 148 T.C. 1, 23 (2017).  Application of that principle usually places the burden of proof on the taxpayer—who is, after all, the party who initially invoked the Court’s jurisdiction by filing a petition.  But when the Commissioner is the party arguing in favor of jurisdiction—for example, in response to a taxpayer’s motion to dismiss—it may be appropriate to place on the Commissioner the burden of proving the facts that establish the Court’s jurisdiction.  See, e.g., Pietanza v. Comm’r, 92 T.C. 729, 736-737 (1989), aff’d, 935 F.2d 1282 (3d Cir. 1991); see also Jimastowlo Oil, LLC v. Comm’r, T.C. Memo. 2013-195.
• In deficiency cases, “it is not the existence of a deficiency but the Commissioner’s determination of a deficiency that provides a predicate for Tax Court jurisdiction.” Hannan v. Comm’r, 52 T.C. 787, 791 (1969).
• In Dees v. Comm’r, 148 T.C. at 5, the Tax Court distilled its prior caselaw into a “two-prong approach to the question of the validity of a notice of deficiency.” In the first step of the Dees approach, the Tax Court “look[s] to see whether the notice objectively put a reasonable taxpayer on notice that the Commissioner determined a deficiency in tax for a particular year and amount.”  at 6.  A notice that meets that test is valid, without the need for further inquiry.  If instead the notice is “ambiguous . . . the party seeking to establish jurisdiction . . . [must] establish that the Commissioner made a determination and that the taxpayer was not misled by the ambiguous notice.”  Id.
• Reg. § 1.1012-1(c)(1) provides: “If shares of stock in a corporation are sold or transferred by a taxpayer who purchased or acquired lots of stock on different dates or at different prices, and the lot from which the stock was sold or transferred cannot be adequately identified, the stock sold or transferred shall be charged against the earliest of such lots purchased or acquired in order to determine the cost or other basis of such stock.”  Moreover, it has long been established that taxpayers bear the burden of proving the basis of property claimed as an offset to the amount realized upon its sale.  See, e.g., Burnet v. Houston, 283 U.S. 223, 227-228 (1931).
• A partnership’s qualification for the small partnership exception must be determined year by year. Reg. § 301.6231(a)(1)-1(a)(3).
• Section 6651(a)(1) provides for an addition to tax when a taxpayer fails to file a timely return. The addition to tax is a prescribed percentage of the amount of tax required to be shown on the return.  (The prescribed percentage increases, up to a stated maximum, according to the extent of the delinquency of the taxpayer’s return.). The Tax Court has jurisdiction to redetermine a taxpayer’s liability for an addition to tax under section 6651(a)(1) only to the extent it is “attributable to a deficiency in tax described in section 6211”.  6656(b)(1).
• Section 6662(a) provides for an accuracy-related penalty equal to 20% of an “underpayment” attributable to specified types of misconduct. The definition of “underpayment” is similar to the definition of “deficiency”—generally equal to the excess of the tax imposed over the tax shown on the taxpayer’s return.  6664(a).
• As the Court of Appeals for the Fifth Circuit observed when it affirmed an order of this Court granting the Commissioner’s motion for summary judgment in Jones v. Comm’r, 338 F.3d 463, 466 (5^th 2003): “The IRS has discretion to accept or reject an amended return.”
• Moreover, Pearce v. Comm’r, 95 T.C. 250 (1990), rev’d, 946 F.2d 1543 (5^th 1991), establishes that the Commissioner’s failure to take into account a taxpayer’s return for a year does not invalidate a notice of deficiency issued for the year.

Insight:  The Stevens case again illustrates the complexity in the old TEFRA regime.  However, fewer of these cases will be heard by the Tax Court as the IRS initiates more partnership examinations under the new BBA audit procedures.

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