Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-ca2-15-01653/USCOURTS-ca2-15-01653-0/pdf.json

Parties Involved:
Jason Chai
Appellant
Commissioner of Internal Revenue
Appellee

Document Text:

15‐1653 (L)

Chai v. Commissioner

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

______________                          

August Term, 2016

(Argued: October 25, 2016          Decided: March 20, 2017)

Docket Nos. 15‐1653 (L); 15‐2414 (XAP)

____________                          

JASON CHAI,

Petitioner‐Appellant‐

Cross‐Appellee,

COMMISSIONER OF INTERNAL REVENUE,

Respondent‐Appellee‐

Cross‐Appellant.

______________

Before:

KATZMANN, Chief Judge, WESLEY and CARNEY, Circuit Judges.

______________

    

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These cross appeals from orders of the United States

Tax Court relate to taxpayer Jason Chai’s underreporting of

income in his 2003 tax return, principally in connection

with a $2 million payment Chai received for his role in a

now‐defunct tax‐shelter scheme.    The Commissioner of

Internal Revenue (the “Commissioner”) issued Chai a

notice of deficiency for failing to pay self‐employment tax

on the payment.    Chai petitioned the Tax Court for

redetermination of that deficiency.    While that deficiency

proceeding was pending, and before the Tax Court had

determined the proper treatment of the $2 million payment,

partnership losses (for an unrelated partnership of which

Chai was a partner) were disallowed in a separate

partnership tax proceeding.   The Commissioner thereafter

asserted by amended answer in Chai’s personal deficiency

proceeding an income‐tax deficiency attributable to the

$2 million payment, in addition to the self‐employment‐tax

deficiency, now that Chai’s partnership losses had been

disallowed.    The Tax Court ultimately sustained the self‐

employment tax deficiency and related penalty, but

dismissed for lack of jurisdiction the Commissioner’s later‐

asserted income‐tax deficiency.    In upholding the penalty

assessment, the Tax Court rejected as untimely Chai’s

argument, raised for the first time in post‐trial briefing, that

the Commissioner failed to carry his burden to show

compliance by the Internal Revenue Service with a written

supervisory approval requirement imposed by statute.  

Chai challenges the ruling upholding his self‐employment‐

tax deficiency and the Tax Court’s refusal to consider his

post‐trial sufficiency challenge with respect to the penalty,

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and the Commissioner challenges the Tax Court’s

jurisdictional ruling with respect to the income‐tax

deficiency.    AFFIRMED IN PART, VACATED IN PART,

REVERSED IN PART, and REMANDED.                

JEREMY KLAUSNER (Frank Agostino,

Lawrence M. Brody, on the brief),

Agostino & Associates, P.C.,

Hackensack, NJ, for Petitioner‐

Appellant‐Cross‐Appellee.  

ARTHUR T. CATTERALL, Attorney, Tax

Division, Department of Justice

(Richard Farber, on the brief), for

Catherine D. Ciraolo, Acting

Assistant Attorney General,

Washington, D.C., for Respondent‐

Appellee‐Cross‐Appellant.  

______________

WESLEY, Circuit Judge:

Taxpayer Jason Chai’s appeal and the Commissioner

of Internal Revenue’s (the “Commissioner”) cross‐appeal

relate to Chai’s underreporting of income in his 2003 tax

return, principally in connection with a $2 million payment

Chai received from Delta Currency Trading, LLC (“Delta”)

for his role in a now‐defunct tax‐shelter scheme.    The

Commissioner issued Chai a timely notice of deficiency

asserting that he owed self‐employment tax on the $2

million payment, plus a 20% accuracy‐related penalty.  The

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original notice of deficiency did not assert an income‐tax

deficiency because the $2 million increase in Chai’s income

was initially offset for income‐tax purposes (but not self‐

employment‐tax purposes) by his reported share of a

partnership loss that could be adjusted only in a separate,

partnership‐level proceeding.    Chai initiated a deficiency

proceeding in the United States Tax Court to challenge the

Commissioner’s self‐employment‐tax determination.

While Chai’s deficiency proceeding was pending,  

losses reported by Mercato Global Opportunities Fund, LP

(“Mercato”)—a partnership of which Chai was a member—

were disallowed in a partnership tax proceeding (the

“Mercato proceeding”).    Chai had reported his share of

Mercato’s losses on his 2003 personal return.  With that loss

disallowed, Chai would also owe income tax on the $2

million payment if the Tax Court decided that the payment

was income.  To collect that tax (and another 20% accuracy

penalty), the Commissioner filed an amended answer in

Chai’s personal deficiency proceeding to assert an income‐

tax deficiency in addition to the original self‐employment‐

tax deficiency.  In separate orders, the Tax Court held (1) it

lacked jurisdiction over the added income‐tax deficiency

because I.R.C. § 6230 required the Commissioner to apply

the results of the Mercato proceeding to Chai by

computational adjustment, rather than in    his deficiency

proceeding, and (2) Chai owed the self‐employment tax and

corresponding penalty.    In upholding the penalty

assessment, the Tax Court rejected as untimely Chai’s

argument, raised for the first time in post‐trial briefing, that

the Commissioner failed to carry its burden to show

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compliance with a statutory written‐approval requirement.  

The Commissioner challenges the first ruling, and Chai

challenges the second.1  

For the reasons discussed below, we hereby:

(1) VACATE the Tax Court’s jurisdictional ruling and,

because Chai concedes that the $2 million payment is fully

taxable, REMAND the case to the Tax Court to enter a

revised decision upholding the income‐tax deficiency;

(2) AFFIRM the portion of the Tax Court’s order upholding

the self‐employment‐tax deficiency; and (3) REVERSE the

portion of the Tax Court’s order upholding the accuracy‐

related penalty.    

 

1 The numbers involved in this litigation are as follows.  On his

2003 tax return, Chai reported an overall loss of $11.47 million

and income tax of $0.  Most of the loss—$11.15 million—was due

to Chai’s participation in the Mercato partnership.  When the IRS

audited Chai’s 2003 return, it adjusted his income upwards by

$2.4 million, largely due to the $2 million Delta payment.  This

still left a loss of approximately $9.1 million.    The IRS’s first

notice of deficiency therefore asserted a $63,751 self‐employment

tax deficiency and a $12,750.20 accuracy‐related penalty.  When

the Mercato proceeding concluded and the partnership loss was

disallowed, Chai’s income was no longer sheltered by the

partnership losses.    Not including the Delta payment, this

brought Chai’s 2003 income to $49,869, for which the IRS issued

a computational adjustment for $10,269 in income tax and a

$2,053.80 penalty.    Including the disputed Delta payment, this

would put his 2003 income just above $2 million, for which the

IRS asserted in its First Amendment to Answer (defined infra) an

income tax deficiency of $563,868.

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BACKGROUND

I. STATUTORY FRAMEWORK

This case involves the complicated intersection of

partnership and individual taxpayer tax court proceedings.  

Before turning to the facts and procedural background of

this case, both of which are encumbered  with terminology

and concepts that have confounded the parties and the Tax

Court, it is helpful to start with a basic outline of the

statutory context underlying this case.   

When the Internal Revenue Service (the “IRS”) audits

an individual taxpayer’s return and determines that he

owes more than he reported, it must follow statutorily

prescribed deficiency procedures to recover unpaid tax,

including unpaid self‐employment tax imposed by I.R.C.

§ 1401(a), as well as any applicable reporting penalty.   See

I.R.C. §§ 6211‐6216, 6665(a)(1).    Those procedures require

the IRS to assert its claim for additional tax and penalty

through a notice of deficiency, which the taxpayer may

challenge by petition filed in the Tax Court within 90 days

of the notice’s issuance.  See I.R.C. §§ 6212(a), 6213(a).   

The Tax Court “exercises jurisdiction only to the

extent provided by statute.”  See GAF Corp. v. Comm’r, 114

T.C. 519, 521 (2000).    Its jurisdiction to redetermine a

deficiency asserted by the IRS “depends upon a valid notice

of deficiency and a timely filed petition.”  Id.; see Moretti v.

Comm’r, 77 F.3d 637, 642 (2d Cir. 1996) (“A notice of

deficiency is . . . considered the jurisdictional prerequisite to

a taxpayer’s suit in the Tax Court for redetermination of his

tax liability.”   (internal quotation marks omitted)).   Where

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the notice of deficiency is invalid, the Tax Court must

dismiss the case.  See GAF Corp., 114 T.C. at 528.  

The IRS is prohibited from assessing and collecting

additional tax deficiencies during the period for filing a Tax

Court petition.  If the taxpayer timely files, that prohibition

remains in place until the decision of the Tax Court

becomes final.  I.R.C. § 6213(a).  Along the same lines, the

statute of limitations on the assessment of any additional

deficiencies is tolled during that period and for 60 days

thereafter.  I.R.C. § 6503(a)(1).

Unlike individuals and corporations, partnerships are

not separately taxable entities. A partnership’s income and

expenses pass through to the individual partners, who must

pay a tax on their proportionate shares of net gain or may

claim a deduction for their shares of net loss.  Partnership

tax is subject to the procedures set forth in the Tax Equity

and Fiscal Responsibility Act of 1982 (“TEFRA”), Pub. L.

No. 97‐248, 96 Stat. 324 (codified as amended at I.R.C.

§§ 6221‐6234).  Central to those procedures is the distinction

between partnership and nonpartnership items.  

“Partnership item[s]” are items more properly determined

at the partnership level than at the partner level—e.g.,

income, gain, loss, deduction, and credit.    I.R.C. §§ 6221,

6231(a)(3). “Nonpartnership item[s]” are all of the

partnership’s remaining income and expenses that are not

“partnership item[s].” I.R.C. § 6231(a)(4).

To initiate adjustments to partnership items, TEFRA

requires the IRS to conduct a unitary audit of the

partnership and issue a final partnership administrative

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adjustment (“FPAA”) to the partners, which the partners

may challenge in a single judicial proceeding (a “TEFRA

proceeding”) in, inter alia, the Tax Court.    See I.R.C.

§§ 6223(a)(2), 6226.    Adjustments to nonpartnership items

follow the standard procedures for adjustments to personal

income. See I.R.C. §§ 6221, 6230(a)(2)(A). The goal of the

TEFRA procedures “is to ensure that, in general,

partnership items are adjusted once at the partnership level.  

All partners, whose tax liability will be affected by its

outcome, have the opportunity to participate in the audit

allowing each to be bound by its result.”    Callaway v.

Comm’r, 231 F.3d 106, 111 (2d Cir. 2000).    

As with the deficiency proceedings for

nonpartnership (i.e., personal) items, the IRS is prohibited

from making FPAA‐related deficiency assessments during

the period in which a partner may challenge the FPAA and,

if a challenge is commenced, until after a final Tax Court

decision is issued.    I.R.C. § 6225(a).    The statute of

limitations is likewise tolled during that period and for one

year after a final decision.  I.R.C. § 6229(d).   

Once a partnership‐level tax proceeding becomes

final (or the time to seek judicial review of the FPAA

expires), the IRS applies the results to each partner’s

personal return and calculates any deficiencies.    If the

deficiency calculation would be purely computational, the

Commissioner issues to the partner a “notice of

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computational adjustment,”2 rather than a notice of

deficiency.  I.R.C. § 6225; see I.R.C. § 6230(a)(1) (“Except [in

certain circumstances], subchapter B of this chapter [i.e.,

deficiency procedures] shall not apply to the assessment or

collection of any computational adjustment.”).; N.C.F.

Energy Partners v. Comm’r, 89 T.C. 741, 744 (1987).    The

deficiency procedures, however, do apply to “affected

items”3 that require an individual, partner‐level factual

determination.4    I.R.C.          § 6230(a)(2)(A).    In such

instances, the IRS is required to issue, within one year of the

outcome of the TEFRA proceeding, an affected‐item notice

of deficiency (unless it can be folded into the partner’s

 

2 I.R.C. § 6230(c)(2)(A). A “computational adjustment” is “the

change in the tax liability of a partner which properly reflects the

treatment under this subchapter of a partnership item.    All

adjustments required to apply the results of a proceeding with

respect to a partnership under this subchapter to an indirect

partner shall be treated as computational adjustments.” I.R.C.

§ 6231(a)(6) (internal citations omitted).   

3 An “affected item” is “any item to the extent such item is

affected by a partnership item.”  I.R.C. § 6231(a)(5).

4 Section 6230(a)(2) also requires deficiency proceedings for items

that have, as a result of the FPAA proceeding, become

nonpartnership items.    I.R.C. § 6230(a)(2)(A)(ii).    But everyone

agrees that provision is not applicable here, except to the extent

it played into the analysis in Harris v. Commissioner, 99 T.C. 121

(1992) (addressed below).  

Case 15-1653, Document 125, 03/20/2017, 1992019, Page9 of 71
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existing deficiency proceeding).5    I.R.C. §§ 6229(d),

6230(a)(2)(A)(i); Treas. Reg. § 301.6231(a)(6)‐1(a)(3).   

The TEFRA provisions (and cases interpreting them)

are clear: Partnership‐level proceedings must be kept

distinct from deficiency proceedings involving individual

partners.    A problem arises, however, where, as here, a

partnership’s net loss is so large that it offsets proposed

adjustments to nonpartnership items in a partner’s personal

deficiency proceeding.    In that case, the loss offset could

eliminate some of the partner’s personal tax deficiencies

(but not others, such as a self‐employment‐tax deficiency),

and the non‐TEFRA adjustments could wind up being

uncollectible because of the expiration of the statute of

limitations vis‐à‐vis nonpartnership items.   

That was the case in Munro v. Commissioner, 92 T.C.

71 (1989).   There, the IRS presumptively—i.e., prior to the

conclusion of ongoing partnership‐level TEFRA

proceedings—issued a notice of deficiency to each partner

that disallowed partnership losses for computation

 

5 Penalties determined in a partnership proceeding, even if they

require a partner‐level substantive determination, are excepted

from the affected‐item notice of deficiency requirement. The

penalty is treated as a purely computational matter and not

subjected to deficiency proceedings.  I.R.C. § 6230(a)(2)(A)(i); see

also I.R.C. § 6221 (requiring partnership level treatment for

partnership items “[e]xcept as otherwise provided”).    That is

why, in Chai’s case, the Commissioner abandoned in the First

Amendment to Answer his claim for the additional penalty.  

Comm’r Br. 17‐18 (citing I.R.C. § 6230(a)(2)(A)(i)).   

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purposes.6  Id. at 72‐73. The taxpayers moved to dismiss for

lack of jurisdiction, asserting that the deficiency was

attributable to partnership‐level adjustments subject to

ongoing TEFRA proceedings.  Id.at 73‐74.  Although the Tax

Court agreed that a deficiency existed and that it had

jurisdiction, the court rejected the IRS computation.    The

court held that partnership items included on a taxpayer’s

return must be “completely ignored [for purposes of]

determin[ing] if a deficiency exists that is attributable to

nonpartnership items.”7   Id. at 74.   This became known as

the “Munro computation.”

But Munro created its own problems for taxpayers

and the IRS.    A taxpayer/partner, for example, who is

subject to concurrent TEFRA and individual deficiency

proceedings could be assessed and required to pay a

deficiency that would have to be returned by the IRS as an

overpayment if partnership losses were ultimately allowed.  

The taxpayer would effectively be without a prepayment

 

6 The IRS asserted a $259,500 adjustment to the Munros’ personal

combined income‐tax liability to account for unclaimed

nonpartnership items and added $54,312 more in income tax as a

result of the disallowed partnership losses, for a total deficiency

of $313,812.   

7 In contrast to the IRS’s computation (which disallowed all

partnership losses), the Tax Court computed the deficiency

attributable to the $259,500 nonpartnership income adjustment to

be the difference between the tax on the Munros’ reported

nonpartnership income ($454,895) and the tax on their adjusted

nonpartnership income ($714,485).   

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forum to litigate the partnership item adjustments.  The IRS

similarly would be unable to adjust various nonpartnership  

deductions where a taxpayer derives income primarily

from a partnership, because the income would have to be

ignored under Munro.    Thus, in 1997, Congress created a

procedure—codified at I.R.C. § 6234—to deal with Munro‐

like situations. See Taxpayer Relief Act of 1997, Pub. L. No.

105‐34, § 1231(a), 111 Stat. 788, 1020‐23, amended by Job

Creation and Worker Assistance Act of 2002, Pub. L. No.

107‐147, § 416(d)(1)(D), 116 Stat. 21, 55.    

Section 6234 is a helpful method for coordinating

deficiency and TEFRA proceedings to avoid the taxpayer

losing out on prepayment rights and the IRS losing its

ability to assess deficiencies attributable to partnership

items.    It provides a declaratory judgment procedure for

adjustments to an oversheltered tax return—that is, a return

that shows no taxable income and a net loss from a TEFRA

partnership proceeding.    I.R.C. § 6234(b).    In such an

instance, the IRS may issue a “notice of adjustment” for

nonpartnership items if “the adjustments resulting from

such determination do not give rise to a deficiency (as

defined in section 6211) but would give rise to a deficiency

if there were no net loss from partnership items.”8   I.R.C.

 

8 Take, for example, a taxpayer/partner who files an

oversheltered return, reporting $500,000 of income and

$1 million of losses (all of which are partnership items). If the IRS

determines that the taxpayer/partner underreported his income

by $300,000, then the taxpayer/partner’s adjusted income,

namely, $800,000, would not give rise to a deficiency, because his

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§ 6234(a)(3).    The taxpayer may challenge the notice of

adjustment within 90 days in the Tax Court, which has

jurisdiction to determine the correctness of the adjustment.  

I.R.C. § 6234(c). If the Tax Court’s decision is upheld (or not

contested) and the taxpayer’s partnership items are

ultimately adjusted in a subsequent TEFRA proceeding, the

IRS may collect any additional deficiency attributable to

nonpartnership items.  If the TEFRA proceedings conclude

before the Tax Court makes a declaration, the notice of

adjustment is treated as a notice of deficiency.    I.R.C.

§ 6234(g)(3).    Finally, if the taxpayer does not contest the

notice within the period to do so, the taxpayer may seek a

refund upon conclusion of the TEFRA proceeding for any

deficiencies attributable to partnership items that were

ultimately upheld.  I.R.C. § 6234(d).   

With that baseline in mind, we turn to the facts of this

case.

II. THE TAX‐SHELTER SCHEME AND CHAI’S ROLE AS

ACCOMMODATING PARTY9  

Chai is a Harvard‐trained architect who got involved

in a substantial tax‐shelter scheme at the urging of Andrew

Beer, after Beer married Chai’s cousin.  Central to the self‐

 

partnership losses would still exceed his income, but would give

rise to a deficiency if the partnership losses were disallowed.  In

such instance, § 6234 would be appropriate.  

9 Unless otherwise noted, the undisputed facts in this section are

taken from the Tax Court opinion appealed from.  See App’x 232‐

64.  

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employment tax inquiry is Chai’s relationship to Beer and

role in the various tax shelters.   

Beer is an investment manager who “created and

marketed several tax shelters directed to wealthy

individuals” in 2000 and 2001.  App’x 234.  The goal was to

reduce the substantial tax liabilities of prospective clients by

generating losses to offset taxable income for a particular

year.  Among the entities Beer formed to market and advise

the tax shelters were Bricolage Capital, LLC (“Bricolage”),

Counterpoint Capital, LLC (“Counterpoint”), and Delta

Currency Trading, LLC (“Delta”). At all relevant times,

Beer owned all or a majority of the interests in Delta,

Bricolage, and Counterpoint (collectively, the “Bricolage

entities”).    Chai never owned an interest in Delta or

Bricolage.    The Bricolage entities shared clients, offices,

employees and resources.     

For their services, the Bricolage entities (and

particularly Beer as majority owner) collected sizable

advisory and client‐facilitation fees.    The shelters shared

three characteristics: (1) each involved a flow‐through

entity (“FTE”); (2) to garner the tax benefits, the FTEs

entered into “straddle” transactions by which gains would

be triggered before the participant entered the shelter and

losses would be triggered thereafter, leaving the participant

with an interest in only the losses; and (3) each required an

accommodation (accommodating party)—a transitory

partner or shareholder—to serve as initial owner of the

straddled gains.  This is where Chai came in.   

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In 2000, Beer offered Chai the opportunity to act as an

accommodating party in exchange for compensation from

the Bricolage entities.    Chai agreed to a $100,000 annual

salary plus a signing bonus and potential discretionary

bonuses.    Beer explained to Chai his integral role in the

schemes as a conduit and assured Chai that the tax

liabilities he incurred in the transactions would be

eliminated by later‐acquired offsetting losses.   

Pursuant to this arrangement, during 2000 and 2001,

Chai served as the accommodating party for at least 131 tax

shelters and reported over $3.2 billion of shelter‐derived

income.    He received and reported equal offsetting losses

during that time.  In his capacity as accommodating party,

Chai executed numerous transactions and traveled to the

offices of Delta and its affiliates “a lot” and “regularly.”  

App’x 238.    Due to travel conflicts with his architecture

business, however, Chai was often unable to be physically

present to sign documents in his capacity as

accommodating party.    To resolve the problem, Chai

formed JJC Trading, LLC (“JJC”) in 2001 at Delta’s

suggestion.  Chai was sole owner of JJC and Bricolage was

named a nonmember‐manager with discretionary and

signatory authority.  

Chai’s friendship with Beer and the resulting

business arrangement proved fruitful for Chai.  In 2000, for

instance, Chai received $1.2 million as a signing bonus from

Counterpoint, and in 2001, he received $1 million from

Delta.    Both entities reported the payments as non‐

employee compensation (on IRS Form 1099‐MISC,

Miscellaneous Income), and Chai reported them as income

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on his tax returns.    Chai also received the agreed‐upon

$100,000 annual salary from Bricolage and Counterpoint in

each of 2001 and 2002.  

On his 2001 return, Chai made a series of income‐

offsetting declarations related to his arrangement with Beer.  

Chai reported on Schedule C10—the form for “Profit or Loss

From Business (Sole Proprietorship)”—that he “‘materially

participate[d]’ in the operation of [JJC’s] business during

2001,” thereby entitling him to favorable treatment under

passive‐loss rules.  Supp. App’x 146.  Chai described certain

capital losses as “disposition[s] of business property,”

which, under I.R.C. § 1231, allowed him to treat JJC’s losses

as ordinary losses.  Supp. App’x 160‐65.  Chai also made a

“mark‐to‐market” election for JJC under I.R.C. § 475(f)—an

election limited to persons “engaged in a trade or business

as a trader in securities.”    Supp. App’x 156, 166; see also

I.R.C. § 475(f)(1)(A)).  

By the end of 2001, all of Chai’s and JJC’s interests in

the tax shelters had been liquidated.    In April 2002, after

Chai received a $1 million payment from Delta, Delta’s

financial officer, Helen Del Bove, emailed Chai that she

 

10 The instructions to Schedule C describe various circumstances

constituting “material participation,” including “participat[ion]

in the activity on a regular, continuous, and substantial basis

during [the tax year],” provided the participation exceeded 100

hours.    2001 Instructions for Schedule C, Profit or Loss From

Business, at C‐2; see Treas. Reg. § 1.469‐5T(a)(7), (b)(2)(iii).   

Case 15-1653, Document 125, 03/20/2017, 1992019, Page16 of 71
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would be “finalizing some numbers within the next week

or so” regarding additional fees he would receive from

Delta in the future.  Supp. App’x 211.   

In February 2003, Chai and Del Bove discussed the

proper tax treatment of a prospective $2 million payment

from Delta to Chai.  Del Bove told Chai that she was going

to wire him the $436,000 remaining in JJC, dissolve that

entity, and pay him another $2 million.  Chai asked her how

the payments should be treated and whether he would be

issued an IRS Form 1099 for the whole amount.  Del Bove

told him multiple times that the $2 million payment was

income and that Delta would report it on his Form 1099 for

2003.    Beer subsequently authorized on behalf of Delta a

payment of $2 million to Chai as a discretionary bonus.  

Delta, consistent with Del Bove’s guidance, treated the

payment as non‐employee compensation on Chai’s Form

1099 for 2003.  

III. CHAI’S 2003 RETURN AND RELATED AUDITS

Chai did not report the $2 million payment from

Delta as taxable income on his 2003 return.    Instead, in

filing his return, he took the position that it constituted the

return of capital from his investments.  Chai, however, was

not a partner of, and did not invest any capital in, Delta.  

And neither Chai nor JJC reported any portion of Delta’s

income or loss in 2003.    No corresponding tax form was

prepared by Delta for Chai.    Chai’s return showed an

overall loss of $11,466,070 (with $0 tax), the majority of

which ($11,149,621) came from his share of partnership

losses claimed by Mercato—a partnership of which Chai

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was a member and that had no direct connection to the $2

million Delta payment.  

The IRS conducted separate, but concurrent, audits

of Chai’s and Mercato’s 2003 returns. The audit of Chai’s

return resulted in a net increase income adjustment of

$2,397,139, primarily due to the unreported $2 million

payment from Delta.  In its May 5, 2009 notice of deficiency

to Chai, the IRS characterized the $2 million Delta payment

as self‐employment income and therefore asserted a

corresponding deficiency in Chai’s self‐employment tax.  At

that time, the IRS did not assert a deficiency in Chai’s

“regular” income tax related to the $2 million payment

because it was prohibited from adjusting Chai’s $11.1

million share of the Mercato loss prior to the conclusion of

the Mercato proceedings.   

Meanwhile, the audit of Mercato led the IRS to issue,

on June 17, 2009, an FPAA that completely disallowed

Mercato’s $110 million claimed loss.  

In separate proceedings over the following years,

Chai challenged the notice of deficiency and Mercato

challenged the FPAA in the Mercato proceedings.   

IV. THE TAX COURT PROCEEDINGS

Soon after filing an answer in Chai’s deficiency

proceeding in the Tax Court, the Commissioner concluded

that, under Munro,

11 he should have included in the May

 

11 Recall that, in Munro, the Tax Court held that where

“partnership items . . . included on [a partner’s] return” may be

Case 15-1653, Document 125, 03/20/2017, 1992019, Page18 of 71
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2009 notice a deficiency in Chai’s income tax that would

result from the approximately $2.4 million upward

adjustment to Chai’s income if his share of the Mercato loss

were removed.    That is, if Chai’s reported $11.1 million

share in Mercato’s losses were ignored, his overall loss

would decrease from approximately $11.5 million to

approximately $400,000; the $2.4 million adjustment would

therefore result in $2 million of taxable income.  On October

30, 2009, the Commissioner filed an Amendment to Answer

in Chai’s deficiency proceeding asserting an additional

deficiency in income tax ($563,868) and a corresponding

additional 20% penalty ($112,773.80).12  

On June 3, 2013, the Mercato proceeding concluded.  

In an order dated September 13, 2013, the Tax Court

disallowed all of Mercato’s losses for 2003.  Under I.R.C. §

6229(d), the IRS had one year from that date to assess any

computational deficiency in Chai’s 2003 income tax and

penalty.   

In December 2013, at the beginning of trial in Chai’s

personal deficiency proceeding, Chai moved to dismiss for

lack of jurisdiction the claims made by the Commissioner in

 

subject to subsequent adjustment in a partnership proceeding,

those items “are completely ignored [for purposes of]

determin[ing] if a deficiency exists that is attributable to

nonpartnership items.”  92 T.C. at 74.   

12 This resulted in a total deficiency in income tax and self‐

employment tax of $627,619 and a total penalty of $125,524, for a

total owed by Chai of $753,143.  

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20

his 2009 Amendment to Answer.13  Chai did not dispute the

disallowance of the Mercato loss.  Instead, he argued that,

rather than asserting the additional claims for income tax

due after disallowance of the Mercato losses in Chai’s

present deficiency proceeding, the Commissioner had to

issue a notice of computational adjustment—the method by

which the IRS notifies partners of purely computational

deficiency assessments and related penalties resulting from

the application of the outcome of a partnership‐level

proceeding to their returns.  See I.R.C. §§ 6225, 6230(a)(1).  

The Commissioner countered that he had “properly

recomputed the [asserted] deficiency and penalty” in the

2009 Amendment to Answer by removing Chai’s share of

the partnership loss from the computation, as required by

Munro.    Supp. App’x 10‐11.    Alternatively, the

Commissioner argued, even if Munro did not apply because

the Munro computation here would effect a complete,

rather than partial, disallowance of the partnership losses,

the Tax Court could “now take jurisdiction and rule on” the

recomputed amounts pursuant to its I.R.C. § 6212

deficiency jurisdiction (as augmented by I.R.C. § 6214(a)).  

 

13 Chai argued that the Commissioner had misconstrued Munro,

and had, in essence, anticipated that the proposed adjustments to

the Mercato partnership return would be vindicated in the

Mercato proceeding in violation of Munro. See Supp. App’x 4

(noting that the Tax Court in Munro “reject[ed the

Commissioner’s] argument that proposed adjustments to

partnership items can be taken into account in computing a

[partner’s] deficiency” (quoting Munro, 92 T.C. at 74)).   

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21

Supp. App’x 17.    In support, the Commissioner relied on

Harris v. Commissioner, 99 T.C. 121, 123 (1992), for the

proposition that “once partnership items are resolved, the

Court may take those partnership items into account for

computational purposes in a [partner’s previously initiated]

deficiency proceeding.”   Supp. App’x 17 (citing Harris, 99

T.C. at 123).   

The Commissioner alternatively argued (as he does

here) that the $2 million payment (or the deficiency

attributable thereto) was an “affected item” under I.R.C.

§§ 6230(a)(2)(A)(i) and 6231(a)(5).    He asserted that the

claim for the increased deficiency was contingent upon the

Tax Court’s resolution of the dispute over the $2 million

payment from Delta, which the IRS termed a substantive

“partner‐level [individual taxpayer] determination” with

respect to an “affected item.”    Supp. App’x 13.    As the

Commissioner has now acknowledged, it was an odd fit.  

Nevertheless, recognizing that the affected‐item argument

might render the Amendment to Answer ineffective to

confer jurisdiction over the additional deficiency, the

Commissioner also sought leave to amend the answer again

to formally reassert the income‐tax deficiency claim now

that the Mercato proceeding was final.14    The Tax Court

 

14 The Commissioner also acknowledged that his argument, if

credited, would render the penalty immediately assessable

under I.R.C. § 6230(a)(2)(A)(i), thereby depriving the Tax Court

of jurisdiction over that claim in the deficiency proceeding.  The

Commissioner abandoned the claim for the penalty.    

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22

granted leave to file what it restyled as the “First

Amendment to Answer” on April 24, 2014.     

V. THE TAX COURT’S RULINGS

A. The Jurisdictional Ruling

On February 13, 2015,15 the Tax Court granted Chai’s

motion to dismiss, holding that it lacked jurisdiction over

the Commissioner’s claim for additional income tax.    The

court agreed with Chai that the 2009 Amendment to

Answer attempted “to increase a taxpayer’s deficiency

based on the Commissioner’s proposed, but unadjudicated,

adjustments to . . . partnership items” in violation of Munro.  

Supp. App’x 40.    The court did not address the

Commissioner’s now‐primary argument that, even if Munro

did not allow the amendment, under Harris the court

obtained jurisdiction over the newly added claims once the

Mercato decision became final simply by virtue of its I.R.C.

§ 6212 deficiency jurisdiction (as augmented by I.R.C.

§ 6214(a)).

The court also rejected the Commissioner’s argument

that it obtained jurisdiction by virtue of the First

Amendment to Answer based on the affected‐item theory.  

The “critical inquiry” under an affected‐item theory, said

the court, was “whether the increased deficiency . . .

requires a partner‐level determination before it can be

assessed.”  Supp. App’x 42.  The court held that it did not:

 

15 This was long after the expiration of the one‐year period within

which the IRS could assess deficiencies by computational

adjustment.  See I.R.C. § 6229(d).

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23

There is no factual determination that must

occur in the petitioner’s deficiency proceeding

before respondent can apply the results of the

[Mercato] proceeding.    The disallowed losses

from the [Mercato] proceeding can be applied

to petitioner’s 2003 income taxes regardless of

the outcome of this deficiency proceeding

(whether the $2 million at issue in this case is

taxable non‐employee compensation or a

return of capital).  

Supp. App’x 43.    In the court’s view, “section 6230(a)(1)

requires that the results of the [Mercato] proceeding be

applied to [Chai] through a Notice of Computational

Adjustment.”  Supp. App’x 43.  Thus, the court found that

the First Amendment to Answer did not give the court

jurisdiction over the increased deficiency.   

The Commissioner moved for reconsideration, noting

that he had already applied the results of the Mercato

proceeding to Chai’s 2003 tax return in an August 2014

notice of computational adjustment—that is, he

automatically applied the disallowed loss to Chai’s then‐

agreed upon income—$49,869—and determined income tax

thereon.    However, the Commissioner explained, the IRS

could not apply the additional deficiency claimed as a

result of the $2 million Delta payment without treating it as

taxable income in its computations.  And it could not treat

the payment as taxable income because the court had not

yet ruled in the deficiency proceeding that Chai had

received the payment as gross income, rather than as a

return of capital or a gift.    In other words, the

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24

Commissioner argued, the partner‐level ruling regarding

the proper treatment of the $2 million payment was

necessary before it could assess the additional deficiency.  

The Tax Court denied the motion for reconsideration,

without comment, on April 16, 2015.      

B. The Self‐Employment Tax Ruling

On May 6, 2015, the Tax Court entered its final

decision upholding the deficiency in Chai’s self‐

employment tax and an accuracy‐related penalty.    The

court noted that “[t]he character of a payment for tax

purposes is determined by the intent of the parties,

particularly the intent of the payor, as disclosed by the

surrounding facts and circumstances.”    App’x 245‐46

(collecting cases).    Gross income, the court explained,

“generally includes all income from whatever source

derived, including compensation for services in the form of

fees, commissions, or fringe benefits.”    App’x 245 (citing

I.R.C. §  61(a)(1)).  A return of capital or receipt of a gift, on

the other hand, is not taxable income.   

Here, the court found that the trial testimony and

record evidence (including the contemporaneous email

exchange with Del Bove and other correspondence between

Chai and Delta personnel) supported the conclusion that

the $2 million payment was compensation subject to self‐

employment tax.    The court rejected Chai’s attempts to

minimize his role in the tax shelters, finding instead that his

role “was a critical component of the transactions and the

tax shelters could not have functioned as planned without

[his] participation.”    App’x 246.    Additionally, the court

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25

found that the evidence contradicted Chai’s

characterization of the payment as a return of capital.  

Instead, the evidence showed that Chai was not a partner or

investor in Delta and did not have a capital investment in

any tax‐shelter entity after 2001.  Neither was the payment

a gift from Beer, the court held, as “[t]he record is devoid of

any evidence suggesting that the payment resulted from

detached and disinterested generosity.” App’x 255.   

Finally, the court held that, as necessary to be subject to

self‐employment tax, “the record demonstrate[d] that

[Chai] accommodated tax shelters with sufficient

continuity, regularity, and a profit motive such that he was

engaged in a trade or business as a tax shelter

accommodating party.”  App’x 253.    

C. The Penalty Ruling

In post‐trial briefing, Chai argued for the first time

that the Commissioner had failed to satisfy his burden of

production under I.R.C. § 7491(c) “by not introducing

evidence of his compliance with section 6751(b)(1),” which

requires written supervisory approval of certain penalty

determinations. App’x 256.  The court declined to consider

Chai’s argument, finding it untimely and that the

Commissioner would be prejudiced by its consideration.  

The court then upheld the 20% accuracy‐related

penalty asserted in the notice of deficiency.  The court held

that the Commissioner had satisfied his burden to prove the

existence and amount of deficiency, and that Chai failed to

satisfy the reasonable‐cause exception because he could not

establish justified reliance on his accountant.  

Case 15-1653, Document 125, 03/20/2017, 1992019, Page25 of 71
26

Chai filed a timely notice of appeal on May 18, 2015,

and the Commissioner filed a notice of cross‐appeal on July

24, 2015.

VI. PROCEEDINGS IN THIS COURT

In January 2016, Chai moved to dismiss as untimely

the Commissioner’s cross‐appeal, arguing that the Tax

Court’s February 2015 jurisdictional order dismissing the

IRS’s claims for the additional deficiency and penalty was

an immediately appealable “dispositive order” within the

meaning of Tax Court Rule 190(b)(1).    In March 2016, a

panel of this Court denied Chai’s motion, citing Estate of

Yaeger v. Commissioner, 801 F.2d 96, 98 (2d Cir. 1986).

DISCUSSION

We review de novo the Tax Court’s legal conclusions

and for clear error its factual findings.  Callaway, 231 F.3d at

115 (citing I.R.C. § 7482(a)(1)).  “In particular, ‘[w]e owe no

deference to the Tax Court’s statutory interpretations, its

relationship to us being that of a district court to a court of

appeals, not that of an administrative agency to a court of

appeals.’” Id. (alteration in original) (quoting Exacto Spring

Corp. v. Comm’r, 196 F.3d 833, 838 (7th Cir. 1999)).      

I. THE JURISDICTIONAL RULING

A. We Have Jurisdiction Over the Commissioner’s

Cross‐Appeal

As an initial matter, Chai again asserts that the

Commissioner’s cross‐appeal is untimely.   While we need

not revisit our prior decision denying his motion to dismiss,

we explain briefly why it stands.   

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27

With exceptions not relevant here, the United States

Courts of Appeals “have exclusive jurisdiction to review

the decisions of the Tax Court . . . in the same manner and

to the same extent as decisions of the district courts in civil

actions tried without a jury.”    I.R.C. § 7482(a)(1).    In the

context of an appeal from a district court decision,

“[f]ederal appellate jurisdiction generally depends on the

existence of a decision by the District Court that ‘ends the

litigation on the merits and leaves nothing for the court to

do but execute the judgment.’”    Coopers & Lybrand v.

Livesay, 437 U.S. 463, 467 (1978) (quoting Catlin v. United

States, 324 U.S. 229, 233 (1945)); see also 28 U.S.C. § 1291

(generally limiting appellate jurisdiction to “appeals from

. . . final decisions of the district courts”).  The Third Circuit

has stated that “[j]urisdiction under section 7482(a)(1) . . .

extends only to a ‘final decision’ of the tax court.”    N.Y.

Football Giants, Inc. v. Comm’r, 349 F.3d 102, 105 (3d Cir.

2003) (quoting Ryan v. Comm’r, 680 F.2d 324, 326 (3d Cir.

1982)).   This Court has held “that Tax Court decisions are

appealable only if they dispose of an entire case.”  Estate of

Yaeger, 801 F.2d at 98.    A notice of appeal from the Tax

Court must be filed within 90 days of the entry of such

“decision,” or within 120 days of the entry of “decision” if

another party has filed a timely notice of appeal.   I.R.C. §

7483.   

Here, the Tax Court entered its final decision on May

6, 2015.16  Chai filed a notice of appeal 12 days later.  The

 

16 The March 2015 Memorandum and Findings of Fact and

Opinion and the April 2015 order were not labeled as

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28

Commissioner filed a notice of appeal on July 24, 2016, 49

days after entry of the Tax Court’s decision and well before

the 120‐day limit set by § 7483.  The Commissioner’s notice

was therefore timely.    

Chai contends that the Commissioner’s notice was

untimely because the Tax Court’s February 13, 2015

dispositive order concerning its jurisdiction over the

income‐tax deficiency was the operative final decision for

the cross‐appeal.  An order is an appealable final decision

only when it was “clearly intended to end a litigation.”  

SongByrd, Inc. v. Estate of Grossman, 206 F.3d 172, 178 (2d

Cir. 2000).  Because the Tax Court’s February 13, 2015 order

was not intended to dispose of the Commissioner’s initial

self‐employment‐tax‐deficiency claim and end the

proceeding in the Tax Court, that order was not

immediately appealable.  See Coopers & Lybrand, 437 U.S. at

467.   

Chai’s central argument that Tax Court Rule

190(b)(1), which provides that a “dispositive order . . . shall

be treated as a decision of the Court for purposes of

appeal,” rendered the February 13, 2015 order immediately

appealable is meritless.  As discussed above, a final decision

must clearly be intended to end the litigation; Rule 190(b)(1)

 

“decisions” and no party has argued that the filing of those

documents began the time for appeal.   The March entry stated

that a “decision” reflecting the opinion would be entered at a

later date.  App’x 264.

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29

does not address finality and must be read in a manner

consistent with the statutory finality requirement.

We also reject Chai’s argument that the February 13,

2015 order was final and appealable under I.R.C.

§ 7481(a)(1), which provides that a “decision of the Tax

Court shall become final . . . [u]pon the expiration of the

time allowed for filing a notice of appeal.”  That subsection

addresses finality only when a “[t]imely notice of appeal

[has] not [been] filed,” see id., without dictating when the

time to file a notice begins. Chai’s argument thus begs the

question in the present case.

B. The Tax Court’s Jurisdictional Ruling was

Incorrect

The odd posture of this case has confounded even the

Commissioner; he has offered several theories to support

his request for reversal, only to abandon them to focus on

others.    The problem is that the Internal Revenue Code’s

jurisdictional provisions have gaps, and this case lands

neatly within one.    The irony is that no one—not even

Chai—disputes that, as a result of the decision in the

Mercato proceeding disallowing the partnership losses, Chai

has $2 million of net income on which he has not paid

income tax.  The question is, can the IRS collect it?   

More precisely, we must decide whether the Tax

Court had jurisdiction over the additional income‐tax

deficiency when the Commissioner filed the First

Amendment to Answer at the conclusion of the Mercato

proceeding, at some earlier time, or not at all.    In plain

English:  Did the Tax Court have the authority to consider

Case 15-1653, Document 125, 03/20/2017, 1992019, Page29 of 71
30

the re‐determination of Chai’s partnership losses in

deciding his income‐tax liability resulting from his receipt

of the $2 million Delta payment—a payment that had

nothing to do with his Mercato partnership interest?   

The Commissioner has abandoned his prior reliance

on Munro and instead advances two somewhat

contradictory arguments as to how the Tax Court erred in

its jurisdictional analysis.  His primary argument is that, for

much the same reasons set forth in Harris, the Tax Court

obtained jurisdiction over the increased deficiency because

the Commissioner’s First Amendment to Answer was filed

after the conclusion of the Mercato proceeding and prior to

the Tax Court’s decision in Chai’s deficiency proceeding.   

Alternatively, the Commissioner argues that the claim for

the increased deficiency is attributable to an “affected

item,” requiring a partner‐level determination.    Chai

responds that Harris is inapposite and that this is not an

affected‐item case.    He seems to suggest, as did the Tax

Court, that the only way for the Commissioner to have

assessed the additional deficiency was by issuing a notice of

computational adjustment” under I.R.C. §  6230(c)(2)(A).  

This case does not fit neatly into the statutory

methods marrying TEFRA and deficiency proceedings.  See

I.R.C. § 6234.  But procedural oddities do not mean the tax

is uncollectible.    For the following reasons, we are

persuaded that the Tax Court erred in dismissing the

Commissioner’s claim for the additional income‐tax

deficiency.

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31

We start with two uncontroversial premises.    First,

the IRS could not have assessed the income‐tax deficiency

attributable to the $2 million Delta payment until the

Mercato proceeding concluded.    It is textbook tax law,

affirmed in Munro, that any increased deficiency (and

penalty) attributable to a proposed, but not‐yet‐adjudicated,

adjustment to a partnership item at issue in a TEFRA

proceeding must await the outcome of the partnership‐level

proceeding.    Munro, 92 T.C. at 74; see also GAF Corp., 114

T.C. at 521‐28 (dismissing for lack of jurisdiction a notice of

deficiency issued prior to the completion of related

partnership‐level proceedings).  Second, as a general matter,

the scope of a deficiency proceeding may be expanded to

cover any additional deficiencies for the tax year beyond

those asserted in a statutorily‐compliant notice of deficiency

that is the subject of the proceeding.    See I.R.C. § 6214(a)

(“[T]he Tax Court shall have jurisdiction to redetermine the

correct amount of the deficiency even if the amount so

redetermined is greater than the amount of the deficiency,

notice of which has been mailed to the taxpayer, and to

determine whether any additional amount, or any addition

to the tax should be assessed, if claim therefor is asserted by

the Secretary [through the Commissioner] at or before the

hearing or a rehearing.”).    

The Tax Court’s decision was, at bottom, based on

the blanket assertion that, because the increased deficiency

was not an “affected item” under § 6230(a)(2)(A)(i), “section

6230(a)(1) require[d] that the results of the [Mercato]

proceeding be applied to [Chai] through a Notice of

Computational Adjustment.”    Supp. App’x 43 (emphasis

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32

added); see I.R.C. § 6230(a)(1) (“Except [in certain

circumstances], subchapter B of this chapter [i.e., deficiency

procedures] shall not apply to the assessment or collection

of any computational adjustment.”).  We agree that neither

the increased deficiency attributable to the $2 million

payment by virtue of the disallowed Mercato losses nor the

$2 million payment itself is an “affected item.”    As the

Commissioner has effectively conceded in arguing its

primary position, the $2 million Delta payment is not an

“affected item,” since “the disallowance of the Mercato loss

has no bearing on whether $2 million is includible in

[Chai’s] income.”  Comm’r Br. 50 n.16.  In other words, the

proper treatment of the $2 million payment was unaffected

by the Mercato proceeding; the disallowance affected only

the tax consequences of that treatment.  And an increased

deficiency in itself is not an affected item for purposes of

§ 6230(a)(2)(A)(i), since that section refers to deficiencies as

attributable to (not themselves constituting) affected items.   

We disagree, however, with the Tax Court’s framing

of the inquiry as “whether the increased deficiency is an

affected item that requires a partner‐level determination

before it can be assessed” and its conclusion that, where

§ 6230(a)(2) does not apply, the results of the partnership‐

level proceeding necessarily must be applied to the taxpayer

through a notice of computational adjustment.    Supp.

App’x 42.    We conclude, to the contrary, that a

computational adjustment is not the only method that may

be employed when § 6230(a)(2) does not apply.    When a

computational adjustment is not feasible, § 6230(a)(1)’s bar

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33

on the use of deficiency procedures does not apply.   This

case illustrates the point.   

The IRS did exactly as the Tax Court prescribed with

respect to the income Chai did report—in the August 2014

computational adjustment, the Commissioner calculated

$10,269 of tax on the $49,869 of other income that Chai

stated on his 2003 return.  The Tax Court and Chai seem to

suggest, however, that the IRS should have also included in

its computational adjustment the income‐tax deficiency

attributable to the unreported $2 million Delta payment.  

But Chai did not report the $2 million payment as income

on his 2003 return. Thus, in order to assess the deficiency

the Commissioner still needed a determination in Chai’s

individual deficiency proceeding as to the nature of the $2

million payment—i.e., as the Tax Court put it, “whether the

$2 million at issue in this case [was] taxable non‐employee

compensation or a [non‐taxable] return of capital.”    Supp.

App’x 43.    The Tax Court and Chai would have the IRS

collect the tax purportedly due on a payment, the treatment

of which was the subject of ongoing deficiency proceedings.   

This is an odd position for Chai to take.    He is

essentially arguing that the Commissioner should have

denied him a prepayment forum to adjudicate the

treatment of the $2 million payment simply by virtue of the

disallowance of the partnership losses, belying a

fundamental axiom of the Federal income tax structure: A

taxpayer is typically “entitled to an appeal and to a

determination of his liability for the tax prior to its

payment.”    Flora v. United States, 362 U.S. 145, 159 (1960)

(quoting H.R. Rep. No. 68‐179, at 7 (1924)).   We have no

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34

doubt that had the Commissioner done as Chai suggests—

assess by computational adjustment a deficiency

attributable to a still‐disputed $2 million payment—Chai

would have cried foul, taking the position exactly opposite

to the one he adopts now.    A notice of computational

adjustment was not the answer.

So what was? It cannot be that the additional

deficiency is insulated from assessment simply because of

the timing of the conclusion of the partnership‐level

proceeding.  By that we mean, had the Mercato proceeding

concluded after the Tax Court determined in Chai’s

deficiency proceeding that the $2 million Delta payment

constituted income, the IRS could have assessed the

additional income‐tax deficiency in a notice of

computational adjustment. But, under the Tax Court’s

approach, the additional tax is unassessable simply because

the Mercato proceeding concluded before the Tax Court

determined the proper treatment of the unreported

$2 million payment—i.e., before the IRS had the legal

predicate to assess Chai’s additional income‐tax deficiency.  

We read neither § 6230 nor any other statutory provision to

require the anomalous result of depriving the Tax Court of

deficiency jurisdiction in all cases where § 6230(a)(2) does

not apply.   

Harris supports our conclusion.    In Harris, the Tax

Court rejected the Commissioner’s argument that it lacked

jurisdiction to consider the effect of a separate TEFRA

partnership proceeding in an ongoing deficiency

proceeding.    The court acknowledged that, under I.R.C.

§ 6230(a)(2)(A)(ii), a TEFRA “settlement is applied to a

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35

partner by means of a computational adjustment and not

under the ordinary deficiency . . . procedures,” but it did

not read that provision to deprive the court “of jurisdiction

to take account of the settled items pursuant to section

6214(b).”  Harris, 99 T.C. at 126.  The court reasoned:

[A]fter a settlement has been reached, the

substantive partnership level issues have been

resolved, and all that remains is the mechanical

procedure of applying such settlement to the

partner.    Once substantive partnership level

determinations have been made, the

congressional objective in enacting the TEFRA

partnership provisions has been accomplished.  

Consequently, the provisions mandating

separation of partner and partnership level

proceedings can be relaxed.

Id. (citing Munro, 92 T.C. at 73‐74).   

The Commissioner reads Harris as standing for

the proposition that the TEFRA‐mandated

adjustments subsequent to the filing of the notice of

deficiency “become subsumed within the partner’s

then‐existing deficiency posture, and the court

continues to exercise its standard deficiency

jurisdiction (as augmented by § 6214(a), if the

subsequent adjustments result in a claim for an

increased deficiency).”    Comm’r Br. 48.    That is,

“once the Mercato decision became final, the resulting

$11.1 million adjustment to [Chai’s] income became

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36

subsumed within his then‐existing deficiency

posture.”  Id.    

Chai responds that the Commissioner’s theory

“attempts to avoid TEFRA and use ordinary deficiency

procedures to apply the results of Mercato to [Chai].”  Chai

Reply Br. 10.   He argues that Harris is inapposite, largely

because of details the Commissioner elided.    Harris, Chai

asserts, relied on the fact that “[w]hen the Commissioner

and a partner enter into a settlement with respect to

partnership items, however, such items become non‐

partnership items.  Sec. 6231(b)(1)(C).”  Chai Reply Br. 12‐13

(alteration in original) (quoting Harris, 99 T.C. at 126

(emphasis added)).    Here, Chai argues, there was no

settlement and the disallowed Mercato losses therefore

were not converted into nonpartnership items.    See Chai

Reply Br. 13‐14.

Chai misreads Harris and § 6230(a)(2)(A)(ii).    True,

settled partnership items become nonpartnership items

pursuant to § 6231(b)(1) and there was no settlement here.  

Also true, § 6230 specifically provides that deficiency

procedures apply to certain “items which have become

nonpartnership items.”    I.R.C. § 6230(a)(2)(A)(ii).    But the

jurisdictional dispute in Harris arose precisely from the fact

that, under § 6230, deficiencies attributable to settled

partnership items—unlike deficiencies attributable to other

“items which have become nonpartnership items”—are

excepted from the deficiency procedures.    I.R.C.

§ 6230(a)(2)(A)(ii) (stating that deficiency procedures apply

to “items which have become nonpartnership items (other

than by reason of section 6231(b)(1)(C))”) (emphasis added));

Case 15-1653, Document 125, 03/20/2017, 1992019, Page36 of 71
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see I.R.C. § 6231(b)(1)(C) (providing that partnership items

become nonpartnership items    upon settlement).    Thus, it

mattered not that the settled items became nonpartnership

items under § 6231(b)(1)(C).  The point is, the settled items

were not subject to the deficiency procedures under

§ 6230(a)(2)(A)(ii), but were nevertheless found to be the

proper subject of a deficiency proceeding by the Harris

court.    Thus, as the Commissioner explains, “for

jurisdictional purposes, the erstwhile partnership items in

Harris are indistinguishable from the Mercato partnership

items.”  Comm’r Reply Br. 10‐11.   

We agree.    Section 6230(a)(2)(A)(ii) was meant “to

enable the Commissioner to collect amounts due as a result

of settlements without the necessity of issuing a statutory

notice of deficiency,” not to deprive the Tax Court of

jurisdiction to decide cases like this.  See Harris, 99 T.C. at

126.  That does not mean purely computational adjustments

will not continue to be assessed via notice of computational

adjustment, outside of normal deficiency procedures.  

Indeed, the IRS used that procedure here.  The results of the

Mercato proceeding—applied to Chai by computational

adjustment—increased Chai’s taxable income to $49,869,17

and § 6230 did not require the Tax Court to ignore the effect

of that increase on the deficiency computation in the

ongoing deficiency proceeding. Rather, the Tax Court had

 

17 This is the amount of Chai’s agreed upon income after taking

account of the disallowed partnership losses, but without

factoring in the $2 million Delta payment because its treatment

was still uncertain.  

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38

jurisdiction to redetermine the deficiency by virtue of I.R.C.

§ 6214(a) upon the conclusion of the Mercato proceeding.  

For those reasons, we hold that the Tax Court erred in

concluding that it lacked jurisdiction over the additional

income‐tax deficiency attributable to the $2 million Delta

payment.   

This result is not inconsistent with I.R.C. § 6234 or

Munro.  At first blush, this would appear the ideal case for

the IRS to issue a § 6234 notice of adjustment, which

provides a declaratory judgment procedure for asserting

deficiencies relating to oversheltered returns prior to the

conclusion of partnership‐level proceedings.  However, the

provision (read literally) does not apply to situations where

the adjustments to nonpartnership items would result in a

deficiency even if the partnership losses were given effect.  

See I.R.C. § 6234(a)(3) (applying where “the adjustments

resulting from such determination do not give rise to a

deficiency (as defined in section 6211) but would give rise

to a deficiency if there were no net loss from partnership

items”).    The typical example is where the IRS asserts a

deficiency in income that would result in an adjusted net

income so much greater than the taxpayer’s partnership

losses that the adjustment would result in a deficiency even

if the partnership losses are allowed.  

But this case is a bit different.  If Chai’s partnership

losses were given effect, the adjustment to Chai’s

nonpartnership item (the $2 million payment) would still

result in a self‐employment tax deficiency (since self‐

employment income is not offset by partnership losses), but

not an income‐tax deficiency (since his partnership losses

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39

would still far exceed his adjusted net income).  Because a

deficiency—albeit not an income‐tax deficiency—would

exist, we agree with the Commissioner that § 6234 was not

available.  See Comm’r Br. 42 (asserting that § 6234 does not

apply “because the adjustment gave rise to an asserted

deficiency in self‐employment tax notwithstanding [Chai’s]

reported share of the Mercato loss”).   

This makes sense in light of § 6234.  Where there is no

deficiency after crediting partnership losses, the IRS cannot

issue a timely notice of deficiency (which would suspend

the limitations period for deficiencies attributable to

nonpartnership item adjustments) prior to the conclusion of

the partnership‐level proceeding; that is where § 6234

comes into play.  But the existence of the self‐employment‐

tax deficiency here gave the IRS a basis for a valid notice of

deficiency, obviating the need for a § 6234 notice.  

Further, in instances like this, where § 6234 does not

apply, Munro typically continues to apply, except, the

Commissioner argues, “where . . . the non‐partnership

income reported on an oversheltered return is itself zero or

negative,” and “the Munro computation [thereby] has the

same effect as a complete disallowance of the partner’s

reported share of the partnership loss, contrary to the intent

of the TEFRA provisions.”    Comm’r Br. 42‐43; accord IRM

4.31.6.2.5.1 (Aug. 1, 2006). While we are skeptical about the

Commissioner’s argument (for reasons set forth in the

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40

margin),18 there is no need to decide whether Munro

applied here.    Munro provides a method for computing

(and suspending the limitation period for) partner‐level

deficiencies attributable to nonpartnership items prior to

the conclusion of the partnership‐level proceedings.  

Because the Mercato proceeding ended before Chai’s

personal deficiency proceeding, Munro is inconsequential.  

Once the Mercato proceeding concluded, the Tax Court had

jurisdiction by virtue of its standard I.R.C. § 6212 deficiency

jurisdiction (as augmented by I.R.C. § 6214(a)).   

II. THE SELF‐EMPLOYMENT TAX RULING

A. Standard of Review

This Court reviews the Tax Court’s factual findings

as to whether Chai’s role in Beer’s tax shelters constituted a

“trade or business” within the meaning of I.R.C. § 1402(a)

under the clearly erroneous standard.    UFCW Local One

Person Fund v. Enivel Props., LLC, 791 F.3d 369, 372 (2d Cir.

2015) (“UFCW Local One”).    “Where there are two

permissible views of the evidence, the factfinder’s choice

 

18 Munro held that partnership items must be “completely

ignored [for purposes of] determin[ing] if a deficiency exists that

is attributable to nonpartnership items.” 92 T.C. at 74.    The

decision contemplates that, even ignoring partnership items, the

deficiency attributable to nonpartnership items may ultimately

be determined to have been overstated if certain partnership

items are upheld.  Munro did not say that it applies only when

the computation would have the effect of a partial, as opposed to

total, disallowance of the partner’s reported share of partnership

losses.   

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41

between them cannot be clearly erroneous.”    Id. (quoting

Banker v. Nighswander, Martin & Mitchell, 37 F.3d 866, 870

(2d Cir. 1994)).  “However, the district court’s application of

those facts to draw conclusions of law . . . is subject to de

novo review.”  Id. (omission in original) (quoting Travellers

Int’l, A.G. v. Trans World Airlines, Inc., 41 F.3d 1570, 1575 (2d

Cir. 1994)).      

B. The Two‐Prong Groetzinger Standard

Under I.R.C. § 1401, self‐employment taxes (which

amount to the equivalent combined Social Security and

Medicare taxes on wages imposed by the Federal Insurance

Contributions Act) are imposed on “the net earnings from

self‐employment derived by an individual . . . during any

taxable year.”  I.R.C. § 1402(b).  “[N]et earnings from self‐

employment” is defined generally as “the gross income

derived by an individual from any trade or business carried

on by such individual.”  I.R.C. § 1402(a) (emphasis added).   

While § 1402 does not define “trade or business,” the

Supreme Court in Commissioner v. Groetzinger, 480 U.S 23,

32‐36 (1987), considered the meaning of the phrase as it

appears in I.R.C. § 162(a).  Groetzinger noted that the terms

are “broad and comprehensive,” id. at 31, and that the

determination of whether a taxpayer is carrying on a trade

or business “requires an examination of the facts in each

case,” id. at 36 (quoting Higgins v. Comm’r, 312 U.S. 212, 217

(1941)).  The Court confined its construction of the term to

the tax statute at issue in that case and “d[id] not purport to

construe the phrase where it appears in other places.”  Id. at

27 n.8.  However, the phrase “trade or business” in § 1401

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42

(at issue here) is to be given the same meaning as the same

phrase in § 162.  I.R.C. § 1402(c).  Thus, as the parties agree,

“Groetzinger’s construction of ‘trade or business’ is the most

helpful authoritative pronouncement available, and worthy

of reliance here.”    UFCW Local One, 791 F.3d at 373.   

Accordingly, for Chai’s role in the tax shelters to be a “trade

or business” under § 1401, he must have engaged in the

activity: “(1) for the primary purpose of income or profit;

and (2) with continuity and regularity.”    Id. (citing

Groetzinger, 480 U.S. at 35).  “A sporadic activity, a hobby,

or an amusement diversion does not qualify.”  Groetzinger,

480 U.S. at 35.   

Primary Purpose

The Tax Court dealt with this prong swiftly, and

rightly so, finding that Chai “was paid for his services

through large lump‐sum payments that were reported by

the payors as nonemployee compensation on Forms 1099

and . . . reported the payments as self‐employment

income.” App’x 253.  As the Commissioner notes, the sums

Chai received from his tax‐shelter dealings “dwarfed the

amounts he reported as income from his partnership

interest in an architectural firm.”  Comm’r Br. 63.  It is quite

clear that Chai’s primary purpose was to earn

compensation in exchange for his services as an

accommodating party.  

Chai asserts that his sole motive was that of an

investor—that he agreed to serve as an accommodating

party only in the hope of reaping investment gains.    The

Tax Court rightly rejected that portrayal of the facts.  Beer

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43

testified that the large sums paid to Chai were largely

derived from the fees that Delta received from its clients,

not from any increase in the value of Chai’s holdings.  The

whole point of the shelter scheme was to neutralize any

purported returns on investment by generating offsetting

losses.   

Chai emphasizes, however, that Beer’s testimony also

explained there was an opportunity to profit on the

underlying investments, and that at least some of the

$2 million payment was “directly attributable to the

profitability of the underlying derivative transactions

entered into by the tax shelter entities.”  Chai Reply Br. 24‐

25.  That may be true, and Chai may have been paid less if

the scheme did not do as well, but there is no evidence that

he stood to go without compensation at all.  That Chai had

an interest in the investment performance of the tax shelters

does not mean he was solely an investor in them.  

Moreover, the unsurprising fact that his payment was, in

part, derived from the shelters’ investment gains does not

negate the fact that it was largely drawn from client fees.  

Chai was not simply an investor in the tax shelters—he

performed a service by acting as an accommodating party

and was compensated as such.    The Tax Court did not

clearly err in discrediting Chai’s contrary testimony and

concluding that he agreed to serve as accommodation party

in order to earn compensation.  

Much of Chai’s argument focuses on factors set forth

in Treas. Reg. § 1.183‐2(b)—the “hobby loss” provision—to

show that he lacked profit motive.    The “hobby loss”

provision is focused on limiting or disallowing deductions

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44

for any activity not denominated a “trade or business”

under § 162 or an activity not engaged in for the production

of income under § 212.  Treas. Reg. § 1.183‐2(a).  The factors

on which Chai relies are meant to guide the analysis of

whether the activities for which a taxpayer has claimed an

I.R.C. § 183 deduction were “carried on primarily as a sport,

hobby, or for recreation,” or instead primarily for profit (in

which case expenses are deductible).    Treas. Reg. § 1.183‐

2(a).  Chai does not (and could not credibly) argue that his

role as accommodating party was purely for pleasure.  Nor

does he assert that his conduct was a hobby; rather, he says

it was to seek a return on investment.    The § 183 factors

were not designed to distinguish between investment

return and profit motives.   Indeed, Chai has cited no case

law applying them to a case like this.    And even to the

extent § 183 is useful in this context, the Tax Court’s factual

conclusion that Chai had a profit motive was not clearly

erroneous.

The Treas. Reg. § 1.183‐2 factors are:

(1) The manner in which the taxpayer carries on the

activity; . . .  

(2) The expertise of the taxpayer or his advisors; . . .

(3) The time and effort expended by the taxpayer in

carrying on the activity; . . .  

(4) Expectation that assets used in the activity may

appreciate in value; . . .  

(5) The success of the taxpayer in carrying on other

similar or dissimilar activities; . . .

(6) The taxpayer’s history of income or losses with

respect to the activity; . . .

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45

(7) The amount of occasional profits, if any, which are

earned; . . .

(8) The financial status of the taxpayer; and . . .  

(9) Elements of personal pleasure or recreation

involved in the activity.

Treas. Reg. § 1.183‐2(b).    Chai admits, and the

Commissioner does not dispute, that factors (4), (7), and (9)

are clearly inapplicable in this case.     The others largely

weigh against Chai.

Manner in which Chai carried on the activity.  Chai

asserts that he did not conduct his accommodating party

activities in a businesslike manner, as “every decision made

with respect to the tax shelter transactions was made by

Bricolage.”    Chai Br. 46.    He further claims that, once JJC

was formed, “[he] did not even have to sign any

documents,” as “Bricolage did everything, including acting

as the managing member of JJC.”  Id.  Again, the Tax Court

reasonably found that Chai engaged in businesslike

activities in his capacity as accommodating party, and he

cannot discount his role by citing his delegation of

authority to an agent.   

Chai nevertheless likens his case to Sloan v.

Commissioner, 55 T.C.M. (CCH) 1238 (1988).  There, Sloan, a

full‐time computer analyst who was also an attorney,

planned to establish his own law practice after he retired

from the U.S. Government, and began performing legal

services for clients on weekends while still in the

Government’s employ.  The Tax Court, analyzing whether

Sloan was engaged in a “trade or business” under

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46

Groetzinger,  held, inter alia, that Sloan did not engage in the

law practice with the primary purpose of earning a profit,

but instead to gain experience that he could use when

practicing in earnest post‐retirement.    Id. at 1241.  

Importantly, Sloan rarely billed clients, was not concerned

with earning a profit, and relied on his computer‐analyst

job as his primary source of income.  Id.

Chai, by contrast, was focused on making a profit

(albeit, he says, through investment income), and his

income from the tax shelters dwarfed the amounts received

from his architecture practice.    His role was far more

businesslike than Sloan’s, and was definitely no hobby.   

Moreover, in attempting to offset income, Chai

described certain capital losses as “disposition[s] of

business property.”    Supp. App’x 156, 160‐65.    As the

Commissioner notes, the use of the term “business

property” suggests reliance on I.R.C. § 1231, which

provides that net losses from sales of “property used in the

trade or business” are treated as ordinary losses.   I.R.C. §

1231(a)(2), (3).  In another offsetting measure, Chai made a

“mark‐to‐market” election for JJC under I.R.C. § 475(f),

Supp. App’x 156, when such elections are limited to

persons “engaged in a trade or business as a trader in

securities,” I.R.C. § 475(f)(1)(A).  Thus, Chai now attempts

to distance himself from his previous position—seeking in

this litigation, as the Tax Court found, to use his delegation

of authority to Bricolage “as a shield” from liability, App’x

252—while in the past having relied on his asserted

businesslike involvement in Bricolage to obtain,

affirmatively, favorable tax treatment.  Chai cannot benefit

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47

from claims of business and trade losses while denying

income from the same endeavor.

Chai’s and his advisor’s expertise.  Chai argues that

he had no expertise in and barely understood tax‐shelter

transactions, and that he “relied solely on Mr. Beer’s

representations that the transactions were legal and might

be profitable.”  Chai Br. 47‐48. He seeks to contrast his case

with Bagley v. United States, 963 F. Supp. 2d 982 (C.D. Cal.

2013).   

In Bagley, the court found that Bagley—who was

assessed income tax on the proceeds from various False

Claims Act (“FCA”) claims he prosecuted—and his private

counsel were essentially operating the business of a private

attorney general, given their vital expertise in prosecuting

FCA cases.  Id. at 996‐97.  Thus, the court found that Bagley

engaged in for‐profit activity.  Id. at 998.  Chai asserts that,

in contrast to himself, Bagley “had first‐hand knowledge of

the fraudulent schemes, and the identity of relevant

witnesses and the location of documentary evidence.”  Chai

Br. 48 (quoting Bagley, 963 F. Supp. 2d. at 995).   

Chai misses the point.    Although Chai was not the

mastermind of the tax‐shelter scheme, the expertise relevant

to our analysis is that of an accommodating party.   While

the role of accommodating party may not require extensive

expertise, Chai (like Bagley) was amply qualified and

proficient in the practice.    Indeed, he carried out his role

successfully for years.  He need not have understood every

piece of the bigger picture; he needed only to have

understood the part he played, which he did.  

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48

Chai additionally asserts that he “received no advice

from anyone regarding being a tax shelter accommodating

party.”  Chai Br. 47.  Even if that is true, it only bolsters the

conclusion that he had the requisite minimal expertise to

support his participation in the venture, since the scheme

functioned with him as an essential cog and no one

suggests that he was deficient in his role.  Just as Bagley’s

“involvement . . . was part and parcel of the business

Bagley was conducting,” Bagley, 963 F. Supp. 2d at 996,

Chai’s role, which he ably fulfilled, was essential to the

functioning of Beer’s tax shelter business.   

Time and effort expended by Chai.    This factor

weighs in Chai’s favor, but does not overcome the rest.  It is

true that Chai’s activities, although regular and continuous,

were not time‐ or effort‐intensive.  But that is a function of

the amount of time and effort required to be in the “trade or

business” of being an accommodating party, and not a

reflection of the nature of the activity.    In other words,

although it may not take much to be an accommodating

party, Chai expended enough effort to be one.

Chai’s success in similar activities.    This factor

deserves little weight, but clearly weighs in Chai’s favor: he

was not involved in similar activities before or after the

activity at issue here.

History of income or loss.   Chai’s history of income

from the tax shelters was regular and substantial, including

lump‐sum payments of $1.2 million in 2000, $1 million in

2001, and $2 million in 2003.    The Bagley court found

sufficient history of income where Bagley received only a

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single FCA payout.  Id. at 997.  Chai’s history of multiple,

yearly, and substantial payouts is even more indicative of

being in the business of being an accommodating party.19  

Amount of occasional profits.  As the Commissioner

points out, Chai omitted any analysis of this factor in his

main brief.  In his Reply, he again skirts the issue.  But the

regulations are clear that “substantial profit,” even if “only

occasional,” is “generally . . . indicative that an activity is

engaged in for profit.”   Treas. Reg. § 1.183‐2(b)(7).   Chai’s

profits were just that—substantial, but occasional.

Chai’s financial status.    Chai misses the point, here,

too.    He argues that “[i]n cases where the taxpayer has

other, full‐time employment, the requisite profit motive is

generally missing.”   Chai Br. 50.   He cites, inter alia, Sloan

and Levinson.  In both cases, however, the activity at issue

was a secondary source of income.   Here, by contrast, the

 

19 Chai cites a single case in which the Tax Court found that a

taxpayer who operated a retail store, but patented a few

inventions for which he settled two patent‐infringement suits.  

The Tax Court held that these activities were not continuous, but

that it was too sporadic to be considered a trade or business.  See

Chai Br. 49‐50 (citing Levinson v. Comm’r, 77 T.C.M. (CCH) 2347

(1999)).  There was nothing sporadic about Chai’s involvement in

or income from the tax shelter; he received regular payments for

the work done during those years. He also misreads the relevant

inquiry as relating to his history of income in prior to his

dealings with Beer.  

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payments Chai received in his capacity as accommodating

party dwarfed his architecture income.  See Comm’r Br. 63

(comparing incomes).   

In light of the foregoing, we conclude that the Tax

Court did not err in finding that Chai had the requisite

profit motive to be engaged in the “trade or business” of

being a tax shelter accommodating party, even assuming

the “hobby loss” provision applies in this case.   

C. Continuity and Regularity

Applying the second Groetzinger prong, the Tax

Court found that “[t]he record demonstrates that [Chai’s]

activities were continuous and regular.” App’x 252.    Chai

testified that he went to Bricolage’s offices “a lot” to execute

voluminous documents in his capacity as accommodating

party.    App’x 252.    The Tax Court found that the

continuous and regular nature of Chai’s activities was not

affected by his “forming JJC, making Bricolage JJC’s

nonmember manager, and giving Bricolage power of

attorney,” particularly because “Bricolage’s actions with

respect to JJC are imputed to [Chai] as his agent.”   App’x

252.  

That finding was bolstered by Chai’s representations

on Schedule C of his 2001 return for JJC, in which he stated

that he “‘materially participate[d]’ in the operation of this

business during 2001,” thereby entitling him to favorable

treatment under passive loss rules.    Supp. App’x 146.   In

defining “material participation,” the instructions to

Schedule C describe various circumstances constituting

“material participation,” including “participat[ion] in the

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51

activity on a regular, continuous, and substantial basis

during [the tax] year,” provided the participation exceeded

100 hours.  2001 Instructions for Schedule C, Profit or Loss

From Business, at C‐2; see Treas. Reg. §§ 1.469‐5T(a)(7),

(b)(2)(iii).   

Attempting to downplay his role, Chai asserts that

what the Tax Court considered “regular” activity “was

nothing more than signing ‘multiple binders’ of documents

to ‘set up [the] corporations’ that Mr. Beer used to facilitate

his tax advantaged transactions.”    Chai Reply Br. 18

(quoting Supp. App’x 209) (alteration in original).    In

support, he emphasizes his own self‐serving testimony and

characterizes his role as including “going to Beer’s offices

for a few hours at a time,” “having no regular schedule and

going to the office only when requested by Bricolage,” and

“not having a physical office, assistant, or receiving mail.”  

Chai Reply Br. 18.    According to Chai, he “did not even

draft the documents he signed; he was nothing more than a

straw man. . . .    He was nothing more than a pawn in a

much bigger game.”    Chai Reply Br. 19, 22.    Chai also

disclaims any knowledge of the implications of his 2001 JJC

return, stating that he “was not involved in the preparation

of the return, and did not understand the complexity or the

positions taken on the return.”  Chai Reply Br. 20.   

At bottom, however, the record on which the Tax

Court relied shows that the testimony of Chai and others,

combined with Chai’s representations on prior year returns,

supports the Tax Court’s conclusion that Chai undertook

his activities with “continuity and regularity.”    See

Groetzinger, 480 U.S. at 35.    While it is true that Chai

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52

maintained his architecture practice and was not as

intimately involved with the nuances of the shelters as

others like Beer, that does not render Chai’s activities

insufficiently regular and continuous for purposes of §

1401.  That Chai has a different view of the evidence does

not mean the Tax Court clearly erred.  See UFCW Local One,

791 F.3d at 372.  The Tax Court therefore properly held the

$2 million Delta payment to constitute taxable self‐

employment income. 20

III. THE PENALTY RULING

Chai argues that the Commissioner failed to meet his

burden on the claim to impose an accuracy‐related penalty.  

 

20 We need not consider Chai’s argument, raised for the first time

on appeal, that the $2 million Delta payment is not subject to

self‐employment tax because he was an employee.   See Baker v.

Dorfman, 239 F.3d 415, 420 (2d Cir. 2000) (“In general, ‘a federal

appellate court does not consider an issue not passed upon

below.’” (quoting Singleton v. Wulff, 428 U.S. 106, 120 (1976))).

In any event, Chai’s argument is meritless.    Chai was an

employee of Counterpoint and Bricolage Capital, but not Delta.  

He collapses all three into “Bricolage” and disregards their legal

separateness.  As the Commissioner explains, however, “[t]here

is no authority for the proposition that a taxpayer’s employment

relationship with one entity precludes him from performing

services for a related entity as an independent contractor.”  

Comm’r Br. 66.    Chai’s employment relationship with

Counterpoint and Bricolage Capital did not make him an

employee, as opposed to an independent contractor, of Delta.    

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Specifically, he argues, as he did in his post‐trial briefing,

that compliance with I.R.C. § 6751(b)(1)’s written‐approval

requirement “is an element of the Commissioner’s claim for

penalties,” and it is therefore “part of the Commissioner’s

burden [of production under § 7491(c)] to demonstrate

compliance with” that requirement.   Chai Br. 53.  Because

Chai raised the issue for the first time post‐trial, the Tax

Court declined to consider it.  

The Commissioner originally did not dispute that the

written‐approval requirement is an element of a penalty

claim so long as § 6751(b)(2)(B) (the electronic‐means

exception) does not apply.  He argued that the Tax Court’s

decision not to consider the argument was not an abuse of

discretion, and that, in any event, the penalty here did not

require written approval because it was of the type assessed

by electronic means.    In a Federal Rule of Appellate

Procedure 28(j) letter, however, the Commissioner now

urges us to adopt the reasoning of the majority of a divided

Tax Court in Graev v. Commissioner, 147 T.C. 16, No. 30638‐

08, 2016 WL 6996650 (2016),21 which held that it is

premature to argue the IRS failed to satisfy the written‐

approval requirements of § 6751(b)(1) until the Tax Court’s

decision on the penalty became final and the IRS assessed

the penalty.  Read that way, the Commissioner argues, the

issue of compliance with the written‐approval requirement

 

21 Nine judges of the Tax Court signed the majority opinion; five

judges signed a dissenting opinion; and three judges concurred

in the judgment only. The concurring opinion did not address

the issue of statutory construction.

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is not ripe for review in a deficiency proceeding, and the

issue of whether the Tax Court permissibly declined to

consider Chai’s argument in such a proceeding is therefore

moot.  This is a notable shift from the Commissioner’s pre‐

Graev position that Chai’s post‐trial argument was too late.  

Now, the Commissioner argues that Chai’s argument was

not too late, but rather premature.  Chai has not addressed

Graev, but we must.

Deciding whether the Tax Court abused its discretion

in failing to consider Chai’s post‐trial challenge requires us

to determine first at what point the IRS’s obligation to

comply with the written‐approval requirement kicks in.  In

other words, if compliance is required but may be obtained

at any time prior to assessment of the penalty then, as the

Commissioner now argues, the Tax Court was not required

address the unripe issue.    But if compliance is required

before penalty proceedings begin, the Tax Court arguably

abused its discretion in failing to consider Chai’s argument.  

Thus, this case requires us to decide which side in

Graev got it right.  On one side, the Graev majority held that

the written approval may be obtained at any time before

the penalty is assessed, and any challenge thereto must be

lodged in a post‐assessment proceeding.  2016 WL 6996650

at *10 & n.13.    On the other side, the five dissenting

members in Graev would hold that written approval must

be obtained prior to the initiation of Tax Court proceedings

regarding penalties.  Id. at *29 (Gustafson, J., dissenting).   

Before turning to Graev, we note that Chai’s was not

an electronic‐means case, and therefore § 6751(b)(1)’s

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55

written‐approval requirement did apply.    The

Commissioner argues that the penalty here was excepted

from § 6751(b)(1)’s written‐approval requirement because it

falls within the categories of penalties “automatically

calculated through electronic means.”    Comm’r Br. 77

(quoting I.R.C. § 6751(b)(2)(B)).    He does not argue that

Chai’s penalty was in fact calculated through electronic

means.    Instead, he cites the Internal Revenue Manual,

which instructs IRS personnel that “the assessment of a

penalty qualifies as one calculated through electronic

means if the penalty is assessed free of any independent

determination by an IRS employee as to whether the

penalty should be imposed against a taxpayer.” Comm’r Br.

78 (quoting IRM 20.1.1.2.3(5) (Aug. 5, 2014)).  

The Commissioner’s argument that the penalty

imposed on Chai was “a matter of a mechanical

computation,” Comm’r Br. 77, is at odds with the nature of

the specific penalty determination in this case.    Here, the

accuracy‐related penalty, arising under I.R.C. § 6662(a), can

be based on an underpayment of tax attributable to one or a

combination of causes set forth under § 6662(b).    The

Commissioner, in the notice of deficiency, attributed Chai’s

underpayment to a substantial understatement of income

tax, under § 6662(b)(2), and/or negligence or disregard of

rules and regulations, under § 6662(b)(1).  We are aware of

no record evidence that this determination (particularly if it

were a decision based on § 6662(b)(1)) was, or could have

been, made electronically through the IMF Automated

Underreporter Program.    See IRM 4.19.3 (Aug. 26, 2016)

(providing instructions for the Automated Underreporter, a

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56

computerized system that uses information return

matching    to identify potentially underreported tax

returns).    

To the contrary, the Notice of Deficiency the

Commissioner issued Chai in May 2009 indicates that the

determinations were made by Deborah Bennett, Technical

Services Territory Manager for the IRS, or a revenue agent

working under her authority.  See App’x 30.  Form 886‐A,

which was included with the Notice of Deficiency, details

why the IRS determined to assess the penalty, including

that the IRS employee determined that Chai lacked

reasonable cause for the underpayment.    See App’x 40‐41.  

The Commissioner’s citation to the instruction manual is

unconvincing, especially in light of the Chief Counsel’s

guidance.  Because Chai’s penalty was not imposed “free of

any independent determination by a Service employee as to

whether the penalty should be imposed,” see I.R.S. Gen. Couns.

Mem. 200211040, at 3 (Jan. 30, 2002) (emphasis added), it

was not “calculated automatically through electronic

means.”    I.R.S. Gen. Couns. Mem. 2014004, at 2 (May 20,

2014).    The IRS was therefore required to obtain written

approval of the penalty pre‐assessment.

We turn, then, to the issue of when that obligation

attached—that is, whether compliance with the written‐

approval requirement of I.R.C. § 6751(b)(1) is an element of

the Commissioner’s penalty claim and therefore part of his

burden of production. See I.R.C. § 7491(c)

(“Notwithstanding any other provision of this title, the

Secretary shall have the burden of production in any court

proceeding with respect to the liability of any individual for

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any penalty, addition to tax, or additional amount imposed

by this title.”).

“As in any case of statutory construction,” we start

our analysis, as did the Graev majority, “with ‘the language

of the statute.’”  Hughes Aircraft Co. v. Jacobson, 525 U.S. 432,

438 (1999) (quoting Estate of Cowart v. Nicklos Drilling Co.,

505 U.S. 469, 475 (1992)). “[W]here the statutory language

provides a clear answer, [our analysis] ends there . . . .”  Id.  

However, “[i]f the meaning of the statute is ambiguous,

[we] may resort to canons of statutory interpretation to help

resolve the ambiguity.”  Auburn Hous. Auth. v. Martinez, 277

F.3d 138, 143 (2d Cir. 2002) (citation omitted). Section

6751(b)(1) provides, in relevant part:  

No penalty under this title shall be assessed

unless the initial determination of such

assessment is personally approved (in writing)

by the immediate supervisor of the individual

making such determination or such higher

level official as the Secretary may designate.

I.R.C. § 6751(b)(1).   

We part ways with the Graev majority in its view that

the statutory language is clear.  See Graev, 2016 WL 6996650,

at *10.   The provision clearly requires written approval of

the “initial determination of . . . assessment” before a

penalty can be assessed.    Its clarity ends there.    The

provision contains no express requirement that the written

approval be obtained at any particular time prior to

assessment.  The Graev majority read the absence of specific

language as to when the prior approval need be obtained to

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mean that no specific timing requirement exists and thus

the written approval need only be obtained at some, but no

particular, time prior to assessment.    We find ambiguity,

however, where the Graev majority found none.   

Understanding § 6751 and appreciating its ambiguity

requires proficiency with the deficiency process.  

“Assessment” is the formal recording of a taxpayer’s tax

liability on the tax rolls.22   See I.R.C. § 6203 (stating that an

assessment is “made by recording the liability of the

taxpayer in the office of the Secretary in accordance with

 

22Treasury Regulation § 301.6203‐1 provides:

The district director and the director of the

regional service center shall appoint one or more

assessment officers. . . . The assessment shall be

made by an assessment officer signing the

summary record of assessment.    The summary

record, through supporting records, shall provide

identification of the taxpayer, the character of the

liability assessed, the taxable period, if applicable,

and the amount of the assessment.  The amount of

the assessment shall, in the case of tax shown on a

return by the taxpayer, be the amount so shown,

and in all other cases the amount of the

assessment shall be the amount shown on the

supporting list or record.    The date of the

assessment is the date the summary record is

signed by an assessment officer.

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rules or regulations prescribed by the Secretary”).    It is

“essentially a bookkeeping notation” of what the taxpayer

is required to pay the Government. Laing v. United States,

423 U.S. 161, 170 n.13 (1976); see Hibbs v. Winn, 542 U.S. 88,

115 (2004) (Kennedy, J., dissenting).  In essence, it is the last

of a number of steps required before the IRS can collect a

“deficiency”—a tax liability greater than what the taxpayer

reported on his return. Before it can “assess” a deficiency,

the IRS must first determine a “deficiency” in a taxpayer’s

liability.  See I.R.C. § 6201(a).  The IRS then announces to the

taxpayer in a notice of deficiency its intention to assess that

deficiency.  See I.R.C. § 6212(a).  If the taxpayer does not file

a Tax Court petition within 90 days, “the deficiency . . .

shall be assessed.”   I.R.C. § 6213(c).   If he does file a Tax

Court petition for a “redetermination of the deficiency”

within the 90‐day period, however, the IRS is restricted

from assessing the deficiency “until the decision of the Tax

Court has become final.”  I.R.C. § 6213(a).  It is then the Tax

Court’s job to determine whether a deficiency should be

assessed and, if so, the amount thereof.  See I.R.C. §§ 6214(a)

(“[T]he Tax Court shall have jurisdiction to redetermine the

correct amount of the deficiency . . . .”), 6215(a) (“[T]he

entire amount redetermined as the deficiency by the

decision of the Tax Court which has become final shall be

assessed . . . .”).  

In light of the historical meaning of “assessment,” we

agree with the Graev dissent that the phrase “initial

determination of such assessment” is ambiguous.    See

Graev, 2016 WL 6996650 at *31 (Gustafson, J., dissenting).  If

“assessment” is the formal recording of a taxpayer’s tax

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liability, then § 6751(b) is unworkable: one can determine a

deficiency, see I.R.C. §§ 6212(a), 6213(a), and whether to

make an assessment, “but one cannot ‘determine’ an

‘assessment.’”  Graev, 2016 WL 6996650 at *31 (Gustafson, J.,

dissenting).  We must therefore “consult legislative history

and other tools of statutory construction to discern

Congress’s meaning.”  United States v. Gayle, 342 F.3d 89, 93

(2d Cir. 2003).  It is particularly useful to “consider reliable

legislative history” in cases like this where “the statute is

susceptible to divergent understandings and, equally

important, where there exists authoritative legislative

history that assists in discerning what Congress actually

meant.”    Id. at 94.    “The most enlightening source of

legislative history is generally a committee report,

particularly a conference committee report, which we have

identified as among ‘the most authoritative and reliable

materials of legislative history.’”    Id. (quoting Disabled in

Action of Metro. N.Y. v. Hammons, 202 F.3d 110, 124 (2d Cir.

2000)).    

The report from the Senate Finance Committee on

§ 6751(b) states clearly the purpose of the provision and

thus Congress’s intent: “The Committee believes that

penalties should only be imposed where appropriate and

not as a bargaining chip.”  S. Rep. No. 105‐174, at 65 (1998).  

The statute was meant to prevent IRS agents from

threatening unjustified penalties to encourage taxpayers to

settle.  IRS Restructuring: Hearings on H.R. 2676 Before the S.

Comm. on Finance, 105th Cong. 92 (1998) (statement of

Stefan F. Tucker, Chair‐Elect, Section of Taxation, American

Bar Association) (“[T]he IRS will often say, if you don’t

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settle, we are going to assert the penalties.”).  That history

strongly rebuts the Graev majority’s view that written

approval may be accomplished at any time prior to, even if

just before, assessment.    Allowing, as would the Graev

majority, an unapproved initial determination of the

penalty to proceed through administrative proceedings,

settlement negotiations, and potential Tax Court

proceedings, only to be approved sometime prior to

assessment would do nothing to stem the abuses

§ 6751(b)(1) was meant to prevent.  The Graev dissent put it

succinctly:

Th[e majority’s] construction is implausible in

the extreme—especially in an instance in

which a penalty assertion becomes the subject

of Tax Court litigation.    Once Chief Counsel

had argued and the Tax Court had held that

the taxpayer is liable for an assessment, the

supervisor’s Johnny‐come‐lately approval of

the “initial determination” would add nothing

to the process.  And where the Tax Court had

held the taxpayer not liable for the penalty, the

supervisor’s consideration of the matter would

then be completely moot.   

Graev, 2016 WL 6996650 at *32 (Gustafson, J., dissenting).  

The Graev majority gave short shrift to the legislative

history, suggesting that the Tax Court’s confirmation in the

deficiency proceeding that the penalty was appropriate in

Graev’s case (regardless of compliance with § 6751(b))

cured any concerns that the penalty was used as a

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bargaining chip.  Graev, 2016 WL 6996650, at *14.  That the

penalty may have been appropriate in Graev, however, does

not change Congress’s intent or alleviate its concerns.    If

deficiency proceeding review of penalty determinations

were sufficient to deter or detect the IRS’s improper

leveraging of undue penalties, then Congress would not

have felt compelled to enact § 7491(c), which places the

burden of production on the IRS in any court proceeding

regarding the liability of a taxpayer for any penalty, along

with § 6751.  More to the point, Tax Court review does not

solve the problem—penalties could still be used as

bargaining chips to prompt settlement negotiations and, if

successful, the Tax Court would be none the wiser (since

the taxpayer would have settled, rather than have filed a

Tax Court petition where the propriety of the penalty could

be litigated).   

Moreover, that the Tax Court found that the penalty

was not improperly used as a bargaining chip in Graev

could just as easily indicate that § 6751 (even if the written

approval had not yet been obtained) is having its intended

effect.    Indeed, the IRS’s current administrative practice

requires a supervisor’s approval to be noted on the form

reflecting the examining agent’s penalty determination or

otherwise be documented in the applicable workpapers.

IRM 20.1.5.1.4.1 (Dec. 13, 2016); accord IRM 20.1.5.1.6(4)

(July 1, 2008); see also IRM 20.1.1.2.3(6) (Aug. 5, 2014) (“The

managerial review and approval must be documented in

writing and retained in the case file.”); IRM 20.1.1.2.3(7)

(Aug. 5, 2014) (“[T]he IRS may wish to provide the taxpayer

with a courtesy copy of the document showing that a

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manager approved the penalties.”).    Of course, the IRS’s

internal guidance is neither legally binding nor entitled to

more deference than its persuasive value.  See Reno v. Koray,

515 U.S. 50, 61 (1995); Buffalo Transp., Inc. v. United States,

844 F.3d 381, 385 (2d Cir. 2016) (citing Skidmore v. Swift &

Co., 323 U.S. 134 (1944)).  But, unlike the Graev majority, we

do not find the guidance merely “salutary” and

“immaterial to our conclusion.”  Graev, 2016 WL 6996650 at

*12.  Rather, it is a persuasive signal of the IRS’s reading of

§ 6751 to require, as Congress intended, supervisory

approval prior to the issuance of a notice of deficiency.   

If supervisory approval is to be required at all, it

must be the case that the approval is obtained when the

supervisor has the discretion to give or withhold it. 23  That

discretion is lost once the Tax Court decision becomes final:

 

23 The Graev court was divided over the import of the clause of

§ 6751(b) requiring written approval of the initial determination

of assessment either by “the immediate supervisor of the

individual making such determination” or by “such higher level

official as the Secretary may designate.”  The dissent argued that,

by using the present participle “making,” as opposed to a past‐

tense verb form (e.g., “supervisor of the individual who made

such determination”), the statute requires that the supervisory

approval occur when    “the individual [is] making such

determination.”   Id. at *30 (Gustafson, J., dissenting) (alteration

in original) (quoting § 6751(b)(1)).    While we are inclined to

disagree with that construction for much the same reasons as did

the Graev majority, see id. at *11 & n.15, it matters not to our

analysis.   It is that supervisory approval is required at all that

persuades us the dissent got it right.

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at that point, § 6215(a) provides that “the entire amount

redetermined as the deficiency . . .    shall be assessed”

(emphasis added).  Thus, supervisory (or designated higher

official) approval, in order to be of any consequence, must

necessarily be obtained before the Tax Court’s decision

becomes final.    After that point, the IRS loses discretion

whether to assess the penalty.  See I.R.C. § 6215(a).   

It is not enough that approval be given before the Tax

Court proceeding ends, however; for the supervisor’s

discretion to be given force, the approval must be issued

before the Tax Court proceeding is even initiated.  Section

6751 requires supervisory approval of “the initial

determination of such assessment” (emphasis added).   As

the Graev dissent points out, the word “initial” is defined as

“having to do with, indicating, or occurring at the

beginning.”  Webster’s New World College Dictionary 735

(4th ed. 2010); see also Black’s Law Dictionary 460 (7th Ed.

1999) (offering as an example of the term “initial

determination” the “first determination made by the Social

Security Administration of a person’s eligibility for

benefits”).    While the IRS might still have discretion to

concede a penalty after a Tax Court proceeding has

commenced, such determination would be final.    The

statute would make little sense if it permitted written

approval of the “initial determination” up until and even

contemporaneously with the IRS’s final determination.   In

essence, the last moment the approval of the initial

determination actually matters is immediately before the

taxpayer files suit (or penalties are asserted in a Tax Court

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proceeding).24  And for that matter, because a taxpayer can

file a tax court petition at any time after receiving a notice

of deficiency, the truly consequential moment of approval

is the IRS’s issuance of the notice of deficiency (or the filing

of an answer or amended answer asserting penalties).  

Thus, we hold that § 6751(b)(1) requires written approval of

the initial penalty determination no later than the date the

IRS issues the notice of deficiency (or files an answer or

amended answer) asserting such penalty.25       

 

24 We note that the Commissioner may, and often does, assert

§ 6662(a) penalties in answers or amended answers, and the Tax

Court obtains jurisdiction pursuant to § 6214.    See Graev, 2016

WL 6996650, at *9 n.9.  Where the IRS moves for leave to assert

penalties in an amended answer, the Tax Court considers the

potential prejudice to the taxpayer of allowing the amendment.  

See Estate of Quick v. Comm’r, 110 T.C. 172, 180 (1998).  

25 The Graev majority and dissent argued at length about why the

effective date of § 6751(b)(1) supports their respective positions.  

As originally enacted, the statute provided: “The amendments

made by this section shall apply to notices issued, and penalties

assessed, after December 31, 2000.”    Internal Revenue Service

Restructuring and Reform Act of 1998, Pub. L. No. 105‐206,

§ 3306(c), 112 Stat. 685, 744.    The Graev majority read the

effective‐date provision to apply differently to subsections (a)

and (b) of § 6751.   That is, that “notices issued” and “penalties

issued” components correspond, respectively, to § 6751(a)

(relating to the computation of penalty included in a “notice”)

and § 6751(b) (relating to approval of penalty “assessment”).  

Read that way, the effective‐date provision, says the Graev

majority, “clearly indicates that [§ 6751(b)] is focused on

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In that vein, we further hold that compliance with

§ 6751(b) is part of the Commissioner’s burden of

production and proof in a deficiency case in which a

penalty is asserted.    As mentioned above, the

Commissioner has the burden of production in any penalty

proceeding.  See I.R.C. § 7491(c) (“[T]he Secretary shall have

the burden of production in any court proceeding with

respect to the liability of any individual for any penalty

. . . .”).  Congress’s intent is clear from the legislative history

of § 7491(c):

[I]n any court proceeding, the Secretary must

initially come forward with evidence that it is

appropriate to apply a particular penalty to

the taxpayer before the court can impose the

penalty.    This provision is not intended to

 

assessment rather than on some earlier event.”  Graev, 2016 WL

6996650, at *13.    The Graev dissent, by contrast, reads the

effective‐date provision to apply equally to both subsections of §

6751.  The dissent sees “notices issued” to refer to penalties for

which notices of deficiencies are required, and “penalties

assessed” to refer to “assessable penalties” that do not require a

“notice.”  Id. at *30‐31 (Gustafson, J., dissenting).  

While both sides present persuasive arguments and

reasonable interpretations of the effective‐date provision, we do

not need to go to such lengths here.  Even were we to credit the

Graev majority’s reading, we do not believe that this ambiguous

provision overcomes the legislative history and requires the

incongruous effects that flow from the majority’s (and the

Commissioner’s) approach.   

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require the Secretary to introduce evidence of

elements such as reasonable cause or

substantial authority.    Rather, the Secretary

must come forward initially with evidence

regarding the appropriateness of applying a

particular penalty to the taxpayer; if the

taxpayer believes that, because of reasonable

cause, substantial authority, or a similar

provision, it is inappropriate to impose the

penalty, it is the taxpayer’s responsibility (and

not the Secretary’s obligation) to raise those

issues.

H. Rep. No. 105‐599, at 241 (1998) (Conf. Rep.).    It is

incumbent on the Commissioner, in order to meet his

burden of production, to “come forward with sufficient

evidence indicating that it is appropriate to impose the

relevant penalty.”    Higbee v. Comm’r, 116 T.C. 438, 446

(2001).  Because § 6751(b)(1) provides that “[n]o penalty . . .

shall be assessed” (emphasis added) unless the written‐

approval requirement is satisfied, it would be inappropriate

to impose a penalty where § 6751(b)(1) was not satisfied.  

Read in conjunction with § 7491(c), the written‐approval

requirement of § 6751(b)(1) is appropriately viewed as an

element of a penalty claim, and therefore part of the IRS’s

prima facie penalty case.26   

 

26 The written‐approval requirement—as a mandatory, statutory

element of a penalty claim—is distinct from affirmative defenses

based on “reasonable cause, substantial authority, or a similar

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The only remaining issue is whether, in light of the

foregoing, the Tax Court abused its discretion in declining

to consider Chai’s post‐trial argument that the

Commissioner had not met its burden of proof with respect

to compliance with the written‐approval requirement of

§ 6751(b)(1).  Chai argues the Tax Court’s timeliness ruling

was wrong in three ways: (1) the issue of the

Commissioner’s failure to meet his burden could not have

arisen until after he failed to do so; (2) the Commissioner

had two separate opportunities after trial to supplement the

record with evidence of compliance, but never did so,

instead arguing that he was prejudiced by the timing of

Chai’s argument; and (3) because Chai raised the issue in

his post‐trial reply to the Commissioner’s post‐trial First

Amendment to Answer, its untimeliness was cured by the

Tax Court’s “relation back” rule.  

Given that § 6751(b)(1) written approval is an

element of a penalty claim and therefore the

Commissioner’s burden to prove, Chai’s post‐trial

argument was tantamount to a post‐trial motion for

judgment as a matter of law.    In other words, Chai is

essentially arguing that the evidence was legally

insufficient to sustain the verdict on the penalty claim.  

Such challenges are properly (if not necessarily) made post‐

trial or at least after the party with the burden rests; the

burdened party—here, the Commissioner—could not have

failed to meet his burden until he concluded his

 

provision,” which need be raised by the taxpayer.   See H. Rep.

No. 105‐599, at 241.  

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presentation of evidence.  In other words, as Chai explains,

the sufficiency of the evidence “could not, by definition,

become an issue until after the Commissioner failed to

establish the elements of its penalty claim.”  Chai Br. 55.    

In that sense, there was no timeliness issue and the

Tax Court’s decision was not, as the Commissioner argues,

discretionary as to whether to consider the issue at all.  

Rather, the Tax Court should have applied the standard

applicable to legal‐sufficiency challenges, which is the same

here as below: whether there was sufficient evidence to

permit a rational juror to find in the Commissioner’s favor.  

See McCarthy v. N.Y.C. Tech. Coll. of City Univ. of N.Y., 202

F.3d 161, 167 (2d Cir. 2000).   If the parties disagreed as to

whether the written approval was an element of the

Commissioner’s penalty case, as they do here, they could

have litigated that before the Tax Court at any point at

which it was raised, including post‐trial.    The Tax Court

then concluding one way or the other could resolve

whether the evidence was sufficient to uphold the penalty.   

Even more, it was not Chai’s obligation to alert the

Commissioner to the elements of his claim, and we fail to

see how raising the issue post‐trial denied the

Commissioner the opportunity to properly rebut the

argument.    Indeed, as Chai notes, “the burden of

production [i]s ‘a party’s obligation to come forward with

evidence to support its claim.’”  Chai Reply Br. 30 (quoting

Dir., Office of Workers’ Comp. Programs, Dep’t of Labor v.

Greenwich Collieries, 512 U.S. 267, 272 (1994) (emphasis

added)).  The Commissioner and the Tax Court’s approach

would require a party to move to dismiss each element of a

Case 15-1653, Document 125, 03/20/2017, 1992019, Page69 of 71
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claim before trial in order to preserve a sufficiency

argument post‐trial.  That cannot be the case.  Thus, the Tax

Court was obligated to consider the issue of whether the

Commissioner had met its burden.   

In responding to Chai’s argument that the

Commissioner had multiple opportunities to supplement

the record with evidence of compliance, the Commissioner

acknowledges that it “is true but irrelevant.”   Comm’r Br.

75 (citing Kaufman v. Comm’r, 784 F.3d 56, 71 (1st Cir. 2015)).  

In Kaufman, the party challenging the Tax Court’s penalty

ruling raised the non‐compliance issue for the first time on

appeal. 784 F.3d at 71.    The First Circuit deemed the

argument unpreserved and rejected the Kaufmans’

argument “that it was the IRS’s burden to show that the

requirements were met, and that the Commissioner cannot

now enlarge the record to demonstrate compliance with

section 6751.”  Id. (internal quotation marks omitted).  The

First Circuit stated that “the question whose burden it was

to show compliance with § 6751 is beside the point,” as

“[t]he Kaufmans had the responsibility of arguing in the Tax

Court that the Commissioner had not complied with the

statute in order to put the Commissioner on notice that the

issue was in dispute.”    Id.    Having failed to make the

argument below, the First Circuit held, “the Kaufmans

cannot now fault the Commissioner for introducing no

evidence to rebut it.”    Id. (citing Hormel v. Helvering, 312

U.S. 552, 556 (1941)).    

Here, by contrast, Chai did raise the written‐approval

issue below and the Tax Court gave the Commissioner an

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opportunity to rebut it.    The Tax Court should have

considered the argument on its merits, as should we.    

With respect to whether there was sufficient evidence

of compliance with § 6751, the answer is clear: there was

not.    In fact, the Commissioner has never said that there

was.  Thus, the Commissioner has failed to meet his burden

of proving compliance with § 6751, a prerequisite to

assessment of the accuracy‐related penalty.   We therefore

reverse the portion of the Tax Court’s order upholding the

penalty assessment.

CONCLUSION

For the foregoing reasons, we hereby (1) VACATE

the Tax Court’s jurisdictional ruling and, because Chai

concedes that the $2 million payment is fully taxable,

REMAND the case to the Tax Court to enter a revised

decision upholding the additional income‐tax deficiency;

(2) AFFIRM the portion of the Tax Court’s order upholding

the self‐employment tax deficiency; and (3) REVERSE the

portion of the Tax Court’s order upholding the accuracy‐

related penalty.     

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