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Parties Involved:
Bausch & Lomb Incorporated
Amicus Curiae for Appellee
Commissioner of Internal Revenue Service
Appellant
DDM Management, Inc.
Appellee
UTAM, Ltd.
Appellee

Document Text:

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued April 5, 2011 Decided June 21, 2011

Resubmitted September 15, 2011

No. 10-1262

UTAM, LTD. AND DDM MANAGEMENT, INC., TAX MATTERS

PARTNER,

APPELLEES

v.

COMMISSIONER OF INTERNAL REVENUE SERVICE,

APPELLANT

Appeal from the United States Tax Court

Gilbert S. Rothenberg, Deputy Assistant Attorney General,

U.S. Department of Justice, argued the cause for appellant. 

With him on the briefs were Michael J. Haungs and Joan I.

Oppenheimer, Attorneys.

James F. Martens argued the cause for appellees. With him

on the brief were Michael B. Seay, Amanda Traphagan, and

Renea Hicks. 

Roger J. Jones, Andrew R. Roberson and Kim Marie

Boylan, were on the brief for amicus curiae Bausch & Lomb

Incorporated in support of appellees.

USCA Case #10-1262 Document #1329778 Filed: 09/15/2011 Page 1 of 10
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Before: SENTELLE, Chief Judge, TATEL, Circuit Judge, and

RANDOLPH, Senior Circuit Judge.

Opinion for the Court filed by Senior Circuit Judge

RANDOLPH.

RANDOLPH, Senior Circuit Judge: This appeal presents two

broad issues. The first is whether an understatement of income

can trigger the six-year, extended tax assessment period under

§ 6501(e)(i)(A) of the Internal Revenue Code (26 U.S.C.) when

the understatement results from an overstatement of basis in sold

property. The second is whether the mailing of a notice of final

partnership administrative adjustment by the IRS tolls an

individual partner’s limitation period under I.R.C. § 6501. In a

companion case, we have resolved the first issue in favor of the

IRS. See Intermountain Ins. Serv. of Vail, LLC v. Comm’r, No.

10-1204 (D.C. Cir. June 21, 2011) (as amended Aug. 18, 2011). 

We write separately to address the second.

The issues arise from the following facts. David Morgan

formed an insurance business under the name “Success Life.” 

He later merged Success Life into UTA Management, an S

corporation he solely owned. (Under the Code, the income and

losses of an S corporation are passed through to its shareholders

for federal tax purposes.) In 1999, Morgan caused UTA

Management’s assets to be contributed to UTAM, a newly

formed limited partnership. UTA Management owned a ninetynine percent partnership interest in UTAM. DDM Management,

a separate S corporation owned by Morgan and members of his

family, held the remaining one percent. Morgan later agreed to

sell the partnership interests of UTA Management and DDM to

an unrelated insurance company.

Before the sale, Morgan entered into a series of transactions

that had the effect of inflating UTA Management’s “outside

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basis” in the UTAM partnership. A partner’s outside basis is the

value assigned to the partner’s investment in his partnership

interest. See Am. Boat Co. v. United States, 583 F.3d 471, 474

n.1 (7th Cir. 2009). When a partner sells his partnership

interest, the basis is subtracted from the sale price to calculate

the partner’s capital gain or loss from the sale. See

I.R.C. §§ 61(a)(3), 1001(a). The higher a partner’s basis, the

lower the income resulting from the sale of the partnership for

federal tax purposes.

To increase UTA Management’s outside basis in the

partnership, Morgan sold short U.S. Treasury notes with a face

value of $38 million, receiving cash proceeds of just under that

amount. In a short-sale transaction, borrowed property is sold,

with the seller incurring an obligation to later buy an equivalent

amount of that property and thus “close” the sale. See generally

Zlotnick v. TIE Commc’ns, 836 F.2d 818, 820 (3d Cir. 1988). 

Morgan transferred the proceeds received from the short sale,

along with the obligation to close the sale, to UTA Management,

which then transferred them to UTAM. By doing so, Morgan

raised UTA Management’s outside basis in the partnership by

nearly $38 million—the amount of the sale proceeds—without

accounting for the corresponding obligation to buy.1

 UTAM

later closed the sale by buying Treasury notes for slightly more

than $38 million, resulting in an overall loss to UTAM from the

transaction.

The sale of UTAM closed on October 19, 1999. Morgan

elected to have the stock sale treated as the sale of UTA

Management’s assets for income tax purposes. The tax

1

 In 2000, the IRS clarified that such transactions—known

popularly as “Son of BOSS” tax shelters—were abusive when used to

generate artificial losses for tax purposes. See I.R.S. Notice 2000–44,

2000–2 C.B. 255.

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consequences of the sale were reflected on UTA Management’s

1999 return, filed on August 15, 2000. Because the short-sale

transactions raised UTA Management’s outside basis in the

partnership to more than $41 million, UTA Management

claimed an overall loss of approximately $13 million. This

number was derived by subtracting UTA Management’s outside

basis from the $28 million received for its interest. Without the

basis increase resulting from the short-sale transactions, UTA

Management would have realized a capital gain of

approximately $25 million. Morgan filed his 1999 individual

return on October 16, 2000. On that return he reported the flow

through loss from the sale.

On October 13, 2006—more than six years after the filing

of UTAM’s 1999 partnership return but less than six years from

the filing of Morgan’s 1999 individual return—the IRS mailed

a notice of final partnership administrative adjustment to DDM

Management (UTAM’s “tax matters” partner) pertaining to

UTAM’s 1999 tax year. In the notice, the IRS adjusted the

firm’s outside partnership basis to zero. The IRS explained that

the short-sale transactions “lacked economic substance, and, in

fact and substance, constitute[d] an economic sham for federal

income tax purposes.” It determined that UTA Management

should have reduced its outside basis to account for the

offsetting obligations that were transferred to UTAM along with

the short-sale proceeds. And it found that UTAM was itself a

sham, existing solely for tax avoidance purposes.

DDM Management filed a timely petition for readjustment

of partnership items with the Tax Court. See I.R.C. § 6226(a). 

DDM and UTAM argued, among other things, that the IRS’s

adjustments were barred by the general three-year limitation

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period for tax assessments in I.R.C. § 6501(a).2

 The Tax Court

agreed, relying on Colony, Inc. v. Commissioner, 357 U.S. 28

(1958). That case, interpreting a predecessor provision to

§ 6501, held that the extended assessment period that applies

when “the taxpayer omits from gross income an amount

properly includible therein which is in excess of 25 percent of

the amount of gross income stated in the return” is not triggered

by an understatement of income resulting from an overstatement

of basis in sold property.3 Id. at 36-38.

2

 That section states, in relevant part: “Except as otherwise

provided in this section, the amount of any tax imposed by this title

shall be assessed within 3 years after the return was filed (whether or

not such return was filed on or after the date prescribed) . . ..” I.R.C.

§ 6501(a).

3

 The extended six-year assessment period is currently located at

I.R.C. § 6501(e)(1)(A). The version of § 6501(e)(1)(A) applicable in

1999, the tax year in question, read:

(e) Substantial omission of items

 Except as otherwise provided in subsection (c)—

(1) Income taxes.—In the case of any tax imposed by subtitle

A—

(A) General Rule.—If the taxpayer omits from gross income

an amount properly includible therein which is in excess of 25

percent of the amount of gross income stated in the return, the

tax may be assessed, or a proceeding in court for the

collection of such tax may be begun without assessment, at

any time within 6 years after the return was filed. For

purposes of this subparagraph—

(i) In the case of a trade or business, the term “gross

income” means the total of the amounts received or

accrued from the sale of goods or services (if such

amounts are required to be shown on the return) prior to

the diminution by the cost of such sales or services; and

(ii) In determining the amount omitted from gross

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For the reasons stated in Intermountain Insurance Service

of Vail, LLC v. Commissioner, No. 10-1204 (D.C. Cir. June 21,

2011) (as amended Aug. 18, 2011), we disagree with the Tax

Court and hold that the six-year limitations period applies with

regard to Morgan’s 1999 return.4 This, however, does not end

the case. UTAM has other defenses the Tax Court did not reach,

defenses that raise issues not presented in Intermountain. For

several reasons, UTAM claims that the mailing of the notice of

final partnership administrative adjustment (usually known

simply as an “FPAA”) to DDM Management did not toll the

running of Morgan’s § 6501 limitations period. In other words,

even though the FPAA came less than six years after Morgan

filed his 1999 return, the limitations period expired during the

proceedings that followed.

To evaluate UTAM’s claims it is necessary to understand

how the Tax Equity and Fiscal Responsibility Act of 1982, Pub.

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

§§ 6221-6232), deals with partnerships. An important point is

that partnerships do not pay taxes; only individual partners do. 

Even so, partnerships must file annual informational returns.

See Petaluma FX Partners, LLC v. Comm’r, 591 F.3d 649, 650

(D.C. Cir. 2010). When the IRS disagrees with how a

income, there shall not be taken into account any amount

which is omitted from gross income stated in the return if

such amount is disclosed in the return, or in a statement

attached to the return, in a manner adequate to apprise the

Secretary of the nature and amount of such item.

I.R.C. § 6501(e)(1)(A) (2000).

4

 We express no view on the question whether the nature and

amount of Morgan’s income was adequately disclosed within the

meaning of I.R.C. § 6501(e)(1)(A)(ii). This issue remains open to the

Tax Court on remand.

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partnership return has reported a “partnership item,”5

 it mails a

notice of final partnership administrative adjustment to the

partners. See I.R.C. § 6223(a); Petaluma FX Partners, 591 F.3d

at 651. If the partnership’s “tax matters partner” wishes to

contest an adjustment, he may file a petition for readjustment

within ninety days. I.R.C. § 6226(a). The petition initiates a

court proceeding to determine all partnership items addressed in

the FPAA. See id. § 6226(f). Only after this proceeding may

the IRS assess any resulting tax against the individual partners. 

Id. § 6225(a).

There is no separate limitations period for the mailing of the

notice of final partnership administrative adjustment. But the

notice would have no point if the IRS sent it after all of the

individual partners’ assessment periods had expired for taxes

reflected in the adjustment. See Rhone-Poulenc Surfactants &

Specialities, L.P. v. Comm’r, 114 T.C. 533, 534-35 (2000). The

Tax Equity and Fiscal Responsibility Act therefore contains a

special provision for calculating a partner’s assessment period

with respect to tax attributable to partnership items and

“affected” items.6

 Normally an individual’s assessment period

is calculated from the date on which he filed his personal return. 

See I.R.C. § 6501(a). But § 6229(a) of the Internal Revenue

Code provides that “the period for assessing any tax imposed by

subtitle A with respect to any person which is attributable to any

partnership item (or affected item) for a partnership taxable year

5

 A partnership item is “any item required to be taken into account

for the partnership’s taxable year under any provision of subtitle A to

the extent regulations prescribed by the Secretary provide that, for

purposes of this subtitle, such item is more appropriately determined

at the partnership level than at the partner level.” I.R.C. § 6231(a)(3).

6

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

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

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shall not expire” before the later of the filing of the partnership

return or the last day for filing such a return, plus three years. 

Subsection 6229(c)(2) extends this three-year assessment

window to six years after the filing of the partnership return

when there is a substantial omission of income on the

partnership return. Id. § 6229(c). These provisions have the

effect of extending an individual partner’s assessment period

whenever the partnership return is filed after that individual’s

personal return.

The provision with which we are concerned—

§ 6229(d)—states that “[i]f notice of a final partnership

administrative adjustment with respect to any taxable year is

mailed to the tax matters partner, the running of the period

specified in [I.R.C. § 6229(a)] . . . shall be suspended” for the

pendency of any proceeding initiated under § 6226 and for one

year thereafter. Id. § 6229(d). UTAM argues that the “period

specified” in § 6229(a) refers only to the assessment period

specific to partnership (and affected) items. Under the parties’

stipulations, this period expired before the IRS mailed the notice

of final partnership administrative adjustment. Thus, UTAM

argues, there was nothing for § 6229(d) to suspend.

Although the Tax Court did not reach the issue, that court’s

en banc opinion in Rhone-Poulenc, 114 T.C. 533, determined

that § 6229(d) suspends the running of an individual partner’s

§ 6501 limitations period when that period is open on the date

the IRS mailed the FPAA. A remand on this particular issue

would therefore serve no useful purpose. The Tax Court has

already stated its position, a position with which we agree for

the reasons that follow.

The only period “specified” in § 6229(a) is “the period for

assessing any tax imposed by subtitle A with respect to any

person which is attributable to any partnership item (or affected

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item) for a partnership taxable year . . ..” Since partnerships are

not taxed, we take this language to refer to a partner’s generally

applicable assessment period as provided in § 6501. See

Andantech, L.L.C. v. Comm’r, 331 F.3d 972, 976-77 (D.C. Cir.

2003). In Morgan’s case, that period is, as we have said, six

years. By the time of the FPAA, the period provided by § 6229

had passed, but the six-year period under § 6501 applicable to

Morgan’s individual return was still running.

Logic does not give starting points. Binding opinions of

this court do. Our decision in Andantech is such a starting point. 

We there decided that § 6229(a) does not provide the maximum

period for assessments, even with respect to partnership items. 

That, we said, is the function of § 6501, which is why the period

set forth there is a “limitation.” Section 6229(a), on the other

hand, is something else again; rather than a limitation, it is a

minimum period for the IRS to take action. Andantech, 331 F.3d

at 976-77. Put differently, § 6229(a) tells us that the IRS has at

least this much time to proceed—but that tells us nothing about

how much beyond this time the IRS has. Yet if we were to

accept UTAM’s position that the FPAA cannot toll individual

partners’ § 6501 periods after the § 6229(a) minimum period

passes, we would be converting the minimum period in many

cases into a limitation period, in contravention of the premise of

Andantech. We therefore hold that the assessment period

suspended pursuant to § 6229(d) is the partner’s open

assessment period under § 6501.7

7

 UTAM argues that even if § 6229(d) can be used to toll a

partner’s open § 6501 period, it did not do so here because the FPAA

adjusted only nonpartnership items and was therefore invalid.

UTAM’s argument rests on certain factual stipulations the parties

made in the Tax Court for purposes of litigating the statute of

limitations issue. But there was no stipulation that the FPAA was

“invalid,” as UTAM claims. The FPAA gave notice of the

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The judgment of the Tax Court on the statute of limitations

issue is reversed. The case is remanded for further proceedings

consistent with this opinion.

So ordered.

Commissioner’s determination of adjustments to partnership items.

See, e.g., Clovis I v. Comm’r, 88 T.C. 980, 982 (1987). These

included sham transactions and their attendant incomes, gains, losses,

and deductions. The nature of the adjustments in the FPAA remained

the same regardless of the limited stipulations; as the stipulations

made clear, whether the evidence ultimately would support the

adjustments was to be determined at trial. We therefore have no reason

to decide whether an “invalid” notice of final partnership

administration adjustment may toll the statutory assessment period.

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