T.C. Memo. 2000-327

UNITED STATES TAX COURT

ALLEN FAMILY FOODS, INC., CHARLES C. ALLEN, III,

 TAX MATTERS PERSON, Petitioner v. COMMISSIONER OF 

INTERNAL REVENUE, Respondent

 ALLEN'S HATCHERY, INC., JOHN R. ALLEN, JR.,

 TAX MATTERS PERSON, Petitioner v. COMMISSIONER OF 

 INTERNAL REVENUE, Respondent

Docket Nos. 18546-99, 18547-99. Filed October 20, 2000.

Robert H. Knapp and John S. Stanton, for petitioners.

Clare J. Brooks and Ronald L. Buch, Jr., for respondent.

MEMORANDUM OPINION

ARMEN, Special Trial Judge: These cases are before the

Court on respondent's Motions to Dismiss for Lack of Jurisdiction

and to Strike. Respondent contends that the Court lacks

jurisdiction in these corporate level proceedings to consider
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1 Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code, as amended, and all Rule

references are to the Tax Court Rules of Practice and Procedure. 

allegations contained in the petitions regarding: (1) The impact

(if any) of the underlying adjustments on shareholder basis and

(2) the accuracy-related penalty under section 6662(a).1 As

explained in detail below, we shall grant respondent's motions in

part by striking: (1) All allegations in the petitions regarding

the specific amounts of the individual shareholders' bases in

their stock and (2) all allegations pertaining to the accuracyrelated penalties under section 6662(a). However, we shall deny

respondent's motions in respect of the allegations in the

petitions that the underlying adjustments in these cases, if

sustained, generally will result (as a matter of law) in bases

adjustments at the shareholder level.

Background

Allen's Hatchery, Inc. (Hatchery), an S corporation

organized under the laws of Delaware, is in the business of

hatching and raising live broiler chickens for resale to chicken

processors. Allen Family Foods, Inc. (Foods), an S corporation

also organized under the laws of Delaware, is in the business of

processing broiler chickens for sale to food retailers. 

Hatchery and Foods are considered brother-sister corporations

insofar as they have the same controlling shareholders. 
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 Respondent issued notices of final S corporation

administrative adjustment (FSAA’s) with respect to Hatchery and

Foods setting forth various adjustments to their corporate income

tax returns for their taxable years ending in 1994, 1995, and

1996. Respondent determined, inter alia, that Hatchery sold its

broiler chickens to Foods at prices below the arm's-length price

mandated by section 482. As a consequence, respondent adjusted

Hatchery's returns by increasing the gross income that Hatchery

earned on its sale of broiler chickens to Foods during the years

in issue and, concomitantly, adjusted Foods’ returns by

increasing Foods' costs of goods sold for the years in issue.

 The FSAA issued with respect to Hatchery included as an

attachment an International Examiner's Report that stated that

accuracy-related penalties under section 6662 should be imposed

at the individual shareholder level. 

The tax matters persons for Hatchery and Foods, referred to

collectively as petitioners, filed timely petitions for

readjustment contesting the FSAA’s. Paragraphs 6(h) through (m)

of those petitions allege as follows:

Paragraphs 6(h) of both the Hatchery and Foods petitions

allege that the Commissioner erred in failing to determine that

the additional income allocated to Hatchery for each of the years

in issue should be treated as a constructive distribution to

Hatchery's shareholders in amounts proportionate to their
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shareholdings and as capital contributions by those same

shareholders to Foods. 

Paragraphs 6(i) of both the Hatchery and Foods petitions

allege that the Commissioner erred in failing to determine an

increase in Foods’ shareholders' bases in their stock equal to

the amount of the constructive contributions that they are deemed

to have made to Foods as a consequence of respondent's section

482 adjustments for each of the years in issue. 

Paragraphs 6(j) of both the Hatchery and Foods petitions

allege that the Commissioner erred in failing to determine that,

as a consequence of the constructive corporate distributions and

shareholder contributions described in paragraphs 6(h) and (i),

Foods shareholders had adequate bases in their Foods stock to

deduct their proportionate shares of the annual losses attributed

to Foods pursuant to respondent's section 482 adjustments and

that the adjustments produced a wash for tax purposes at the

individual shareholder level.

Paragraphs 6(k), (l), and (m) of the Hatchery petition

contain allegations contesting the accuracy-related penalties

under section 6662. The petition alleges that the Commissioner

erred in determining that accuracy-related penalties are

applicable to the section 482 adjustments in dispute and that the

Commissioner erred in determining that the penalties are not 

subchapter S items subject to review in these proceedings.
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2 Insofar as the paragraphs of the petitions described

above are concerned, we regard respondent as moving to strike

paragraphs 6(i) and (j) of both the Hatchery and Foods petitions, 

as well as paragraphs 6(k), (l), and (m) of the Hatchery

petition.

3 Subchapter D of chapter 63 of subtitle F, consisting of

secs. 6241-6245, was codified pursuant to the Subchapter S

Revision Act of 1982, Pub. L. 97-354, sec. 4(a), 96 Stat. 1691-

1692. This subchapter was repealed applicable to tax years

(continued...)

As indicated, respondent filed Motions to Dismiss for Lack

of Jurisdiction and to Strike the allegations in the petitions

relating to shareholder basis and the accuracy-related penalty.2

Petitioners filed objections to respondent's motions.

These cases were called for hearing at the Court's motions

session in Washington, D.C. Counsel for both parties appeared at

the hearing and offered argument in support of their respective

positions. Following the hearing, both parties filed memoranda

with the Court.

Discussion

The Tax Court is a court of limited jurisdiction, and we may

exercise our jurisdiction only to the extent authorized by

Congress. See sec. 7442; Judge v. Commissioner, 88 T.C. 1175,

1180-1181 (1987); Naftel v. Commissioner, 85 T.C. 527, 529

(1985). 

These cases are before the Court pursuant to the unified

subchapter S corporation audit and litigation procedures set

forth in subchapter D of chapter 63 of subtitle F.3 The
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3(...continued)

beginning after Dec. 31, 1996, by the Small Business Job

Protection Act of 1996, Pub. L. 104-188, sec. 1307(c)(1), 110

Stat. 1781.

governing statutory provisions, set forth in sections 6241-6245, 

generally provide that the proper tax treatment of S corporation

items shall be determined in a single, unified proceeding at the

corporate (as opposed to individual shareholder) level. See

Eastern States Cas. Agency, Inc. v. Commissioner, 96 T.C. 773,

775 (1991); Dial, Inc. v. Commissioner, 95 T.C. 1, 1-2 (1990). 

In this regard, section 6245 provides: 

SEC. 6245. * * * the term "subchapter S item" means any

item of an S corporation to the extent regulations

prescribed by the Secretary provide that, for purposes

of this subtitle, such item is more appropriately

determined at the corporate level than at the

shareholder level.

It is well settled that items requiring factual

determinations at the individual shareholder level; i.e., socalled affected items, are beyond the scope of the Court's

jurisdiction in a corporate level proceeding. See sec. 6244

(making certain procedural provisions of the unified partnership

audit and litigation procedures set forth in secs. 6221-6234

applicable to S corporations); N.C.F. Energy Partners v.

Commissioner, 89 T.C. 741, 744 (1987); see also Hang v.

Commissioner, 95 T.C. 74 (1990).
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A. Shareholder Basis

Section 301.6245-1T, Temporary Proced. & Admin. Regs., 52

Fed. Reg. 3003 (Jan. 30, 1987), provides a laundry list of

subchapter S items; i.e., items that are required to be taken

into account for the taxable year of an S corporation, that the

Secretary has determined are more appropriately determined at the

corporate level than at the shareholder level. Specifically,

section 301.6245-1T(a)(5), Temporary Proced. & Admin. Regs.,

supra, includes in such list of subchapter S items the following:

(5) Items relating to the following transactions,

to the extent that a determination of such items can be

made from determinations that the corporation is

required to make with respect to an amount, the

character of an amount, or the percentage of stock

ownership of a shareholder in the corporation, for

purposes of the corporation's books and records or for

purposes of furnishing information to a shareholder:

(i) Contributions to the corporation; and

(ii) Distributions from the corporation.

In sum, section 301.6245-1T(a)(5), Temporary Proced. & Admin.

Regs., supra, provides that subchapter S items include items

related to shareholder contributions and corporate distributions

to the extent that a determination of such items can be made from

determinations that the corporation is required to make with

respect to the character or amount of a contribution or

distribution for purposes of the corporation's books and records

or for purposes of furnishing information to a shareholder.
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Section 301.6245-1T(c), Temporary Proced. & Admin. Regs., 52

Fed. Reg. 3004 (Jan. 30, 1987), provides in pertinent part:

(c) Illustrations–-(1) In general. This paragraph

(c) illustrates the provisions of paragraph (a)(5) of

this section. The determinations illustrated in this

paragraph (c) that the corporation is required to make

are not exhaustive; there may be additional

determinations that the corporation is required to make

which relate to a determination listed in paragraph

(a)(5) of this section. The critical element is that

the corporation is required to make a determination

with respect to a matter for the purposes stated;

failure by the corporation actually to make a

determination (for example, because it does not

maintain proper books and records) does not prevent an

item from being a subchapter S item.

 (2) Contributions. For purposes of its books

and records, or for purposes of furnishing information

to a shareholder, the S corporation must determine:

(i) The character of the amount received by

the corporation (for example, whether it is a

contribution, loan, or repayment of a loan);

 * * * * * * *

To the extent that a determination of an item relating

to a contribution can be made from these and similar

determinations that the corporation is required to

make, that item is a subchapter S item. To the extent

that the determination requires other information,

however, that item is not a subchapter S item. Such

other information would include those factors used in

determining whether there is recapture under section 47

by the contributing shareholder of the general business

credit because of the contribution of property in

circumstances in which that determination is irrelevant

to the corporation.

 (3) Distributions. For purposes of its books

and records, or for purposes of furnishing information

to a shareholder, the S corporation must determine:

(i) The character of the amount transferred
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to a shareholder (for example, whether it is a

dividend, compensation, loan, or repayment of a loan);

(ii) The amount of money distributed to a

shareholder;

* * * * * * *

To the extent that a determination of an item relating

to a distribution can be made from these and similar

determinations that the corporation is required to

make, that item is a subchapter S item. To the extent

that the determination requires other information,

however, that item is not a subchapter S item. Such

other information would include the determination of a

shareholder's basis in the shareholder's stock or in

the indebtedness of the S corporation to the

shareholder.

In sum, section 301.6245-1T(c), Temporary Proced. & Admin. Regs.,

supra, provides in pertinent part: (1) An S corporation is

required to make determinations regarding the character and

amount of corporate distributions and shareholder contributions;

and (2) the determination of an item relating to such corporate

distributions and shareholder contributions qualifies as a

subchapter S item where the determination does not require "other

information" such as shareholder basis. 

The parties agree that if the Court should sustain the

section 482 adjustments set forth in the FSAA’s, then the Court

would have jurisdiction to decide whether those adjustments

resulted in constructive corporate distributions and/or

shareholder contributions in these corporate level proceedings.

In other words, the parties agree that constructive corporate
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distributions and/or shareholder contributions in this context

constitute subchapter S items pursuant to section 301.6245-

1T(a)(5), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 3003

(Jan. 30, 1987).

On the other hand, the parties disagree whether the abovequoted regulations expand the scope of the term "subchapter S

item" to encompass the determinations regarding shareholder basis

that petitioners seek to place in dispute in these cases. 

Petitioners contend that, inasmuch as constructive corporate

distributions and/or shareholder contributions are considered

subchapter S items, the Court's jurisdiction encompasses the

legal question whether such constructive corporate distributions

and/or shareholder contributions will result in adjustments to

the shareholders' bases in their stockholdings. Petitioners rely

on the flush language of section 301.6245-1T(c)(2), Temporary

Proced. & Admin. Regs., 52 Fed. Reg. 3004 (Jan. 30, 1987), and

Dakotah Hills Offices Ltd. Partnership v. Commissioner, T.C.

Memo. 1996-35, in support of their position. Respondent counters

that the Court's holding in Dial, Inc. v. Commissioner, 95 T.C. 1

(1990), is controlling, and that the matters relating to

shareholder basis that petitioners are attempting to place in

dispute do not constitute subchapter S items.

Our review of the allegations in the petitions that

respondent finds objectionable reveals that petitioners in fact
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4 Sec. 1366(d)(1) provides that if an S corporation

sustains a loss, an individual shareholder's deduction of his or

her pro rata share of the loss is limited to the shareholder’s

adjusted basis in the stock and the indebtedness of the

corporation to the shareholder.

make two arguments relating to shareholder basis. First,

petitioners allege that if the Court should sustain respondent's

section 482 adjustments and conclude that such adjustments result

in constructive corporate distributions and/or shareholder

contributions, then the Court should address the legal question

whether such constructive corporate distributions and/or

shareholder contributions generally will result in adjustments to

the shareholders' bases in their stockholdings. Second,

petitioners allege that if the Court should sustain respondent's

section 482 adjustments and conclude that such adjustments result

in constructive corporate distributions and/or shareholder

contributions, then the resulting constructive shareholder

contributions to Foods would give Foods’ shareholders sufficient

bases in their stock to allow them to recognize their pro rata

shares of Foods' losses, thereby offsetting the taxable gains

associated with the section 482 adjustments to Hatchery's gross

sales.4

In Dial, Inc. v. Commissioner, supra, a proceeding brought

under the unified subchapter S corporation audit and litigation

provisions, the Court, sua sponte, challenged (and ultimately
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denied) the Commissioner's Motion for Entry of Decision where the

Commissioner's proposed decision document included language by

which the Court would purportedly decide the individual

shareholders' bases in the S corporation during the year in

issue. Focusing on the language contained in section 301.6245-

1T(c), Temporary Proced. & Admin. Regs., which states that the

critical element classifying an item as a subchapter S item is

whether the S corporation was required to make a determination

with respect to a matter, the Court noted that the Commissioner

had not argued that an individual shareholder's basis in an S

corporation is an item that is required to be taken into account

for the taxable year of an S corporation. See Dial, Inc. v.

Commissioner, supra at 4. The Court also noted that there are

situations where the amount of an individual shareholder's basis

simply cannot be determined from items that the corporation is

required to take into account. See id. Finally, the Court

rejected the Commissioner's argument that the Court could decide

the amount of the shareholders' bases "in a qualified manner that

acknowledges that other factors might change the basis figures". 

Id. at 4-6.

In University Heights v. Commissioner, 97 T.C. 278 (1991),

the Court followed its holding in Dial, Inc. v. Commissioner,

supra, that the amount of an individual shareholder's basis in an

S corporation is not a subchapter S item. 
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Consistent with Dial, Inc. v. Commissioner, supra, and

University Heights v. Commissioner, supra, we hold that the Court

lacks jurisdiction in these corporate level proceedings to decide

the amount of individual shareholders' bases in their stock in

Hatchery or Foods. It follows that if we should sustain

respondent's adjustments under section 482 and if we decide that

such adjustments result in constructive corporate distributions

and/or shareholder contributions, then we lack jurisdiction to

decide whether Foods shareholders have sufficient bases in their

stock to allow them to recognize their pro rata shares of Foods

losses. Consequently, we shall grant respondent's motion to

dismiss for lack of jurisdiction and to strike insofar as

respondent moves with respect to any such allegations.

The more difficult question is whether we have jurisdiction

in these corporate level proceedings to consider the legal

question whether constructive corporate distributions and/or

shareholder contributions generally will result in adjustments to

the individual shareholders' bases in their S corporation stock. 

Significantly, the Court in Dial, Inc. v. Commissioner, supra,

was not presented with this particular issue. For the reasons

set forth below, we conclude that the Court does have

jurisdiction to consider this issue in these corporate level

proceedings.

As noted earlier, the parties agree that if the Court should

sustain respondent's section 482 adjustments, then the Court
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would have jurisdiction to decide whether such adjustments result

in constructive corporate distributions and/or shareholder

contributions in these corporate level proceedings. The parties

agree that, in this context, constructive corporate distributions

and/or shareholder contributions qualify as subchapter S items. 

As such, the corporation must either record these items on its

books and records or provide information regarding these items to

its shareholders. 

Under the circumstances, we agree with petitioners that the

legal question whether such constructive corporate distributions

and/or shareholder contributions generally will result in

adjustments to the bases of the individual shareholders in their

S corporation stock constitutes a subchapter S item within the

meaning of the flush language of section 301.6245-1T(c)(2) and

(3), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 3004 (Jan.

30, 1987). Section 301.6245-1T(c)(2)(iii), Temporary Proced. &

Admin. Regs., supra, provides in pertinent part:

To the extent that a determination of an item relating

to a contribution can be made from these and similar

determinations that the corporation is required to

make, that item is a subchapter S item. To the extent

that the determination requires other information,

however, that item is not a subchapter S item.

In short, we conclude that the legal question concerning the

proper basis treatment in respect of a constructive corporate

distribution and/or shareholder contribution qualifies as an item

relating to a contribution or distribution that can be determined
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(and to a large extent follows) from the determination that the

corporation is required to make regarding the character and

amount of a corporate distribution or shareholder contribution. 

See University Heights v. Commissioner, supra at 281, in which we

held that the Court has jurisdiction over subchapter S items

(including shareholder contributions) that affect shareholder

basis. Because we are not determining the specific amount of an

individual shareholder's basis but are merely deciding the legal

character of constructive corporate distributions and/or

shareholder contributions and whether these items will affect

shareholders' bases in their stock, we have no need to consider

or rely upon "other information" within the meaning of the

regulations.

As a final matter, we observe that our holding on this point

is consonant with the basic policy underlying the unified

subchapter S corporation audit and litigation procedures; namely, 

the consistent treatment of subchapter S items among S

corporation shareholders. See S. Rept. 97-640, at 25 (1982),

1982-2 C.B. 718, 729. The failure to resolve the proper basis

treatment of constructive corporate distributions and shareholder

contributions at the corporate level would open the door for

inconsistent treatment of such items at the individual

shareholder level. Accordingly, we shall deny respondent's

motions to dismiss for lack of jurisdiction and to strike insofar

as respondent moves with respect to paragraphs 6(i) of both the
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Hatchery and Foods petitions. 

B. Accuracy-Related Penalty

Respondent has also moved to dismiss for lack of

jurisdiction and to strike all allegations in the Hatchery

petition that pertain to the accuracy-related penalties.

Petitioner contends that the accuracy-related penalties

constitute subchapter S items inasmuch as many of the elements

necessary to sustain the penalties require the development of

facts that are within the exclusive knowledge of the corporations

and their officers.

Section 6244 provides in pertinent part that the provisions

of subchapter C that relate to assessing deficiencies with

respect to partnership items and judicial determination of

partnership items are, except as provided in regulations, made

applicable to subchapter S items. Accordingly, we look to the

partnership provisions and case law for guidance in deciding

whether the accuracy-related penalty is a subchapter S item. 

In the partnership context, there is a well-settled

distinction between partnership items and affected items. An

affected item is one that is dependent on factual determinations

to be made at the individual partner level. See N.C.F. Energy

Partners v. Commissioner, 89 T.C. 741, 744 (1989). Section

6230(a)(2)(A)(i) provides that the normal deficiency procedures

apply to those affected items that require partner level

determinations. Traditionally, additions to tax were considered
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affected items requiring factual determinations at the individual

partner level. See N.C.F. Energy Partners v. Commissioner, supra

at 745; see also sec. 301.6231(a)(5)-1T(d), Temporary Proced. &

Admin. Regs., 52 Fed. Reg. 6790 (Mar. 5, 1987).

In N.C.F. Energy Partners v. Commissioner, supra, a case

similar in many respects to the case before the Court, the

Commissioner issued a notice of final partnership administrative

adjustment with respect to N.C.F. Energy Partners (NCF)

determining adjustments to NCF's tax returns for 1982 and 1983. 

The FPAA was accompanied by an explanation of items stating that

the Commissioner intended to assert additions to tax (including

additions to tax under section 6661) at the individual partner

level. The tax matters partner filed a petition for readjustment

on NCF's behalf contesting both adjustments to partnership items

and the various additions to tax mentioned in the explanation of

items. The Commissioner moved to dismiss for lack of

jurisdiction and to strike the allegations in the petition

pertaining to additions to tax on the ground that such items

constituted affected items that could be resolved only at the

individual partner level following the completion of partnership

level proceedings.

The Court agreed with the Commissioner that the additions to

tax in question were affected items that could not be raised in

the partnership level proceeding. With regard to additions to

tax for negligence, the Court stated in pertinent part:
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a partner will be liable for the addition to tax for

negligence pursuant to section 6653(a) if he has an

underpayment of tax some part of which is due to

negligence. The existence of an underpayment of tax at

the partner level cannot be made until the partner's

share of distributable items of income, loss,

deduction, and credit is determined in the partnership

level proceeding. Once the partnership level

proceeding ends, however, the factual question of

whether any part of the underpayment was due to the

partner's negligence must be answered at the partner

level.

N.C.F. Energy Partners v. Commissioner, supra at 744-745.

In the Omnibus Budget Reconciliation Act of 1989, Pub. L.

101-239, sec. 7721, 103 Stat. 2106, 2395-2397, Congress

consolidated the additions to tax for negligence and substantial

understatement under new section 6662 entitled "Imposition of

Accuracy-Related Penalty". Although respondent never amended

sec. 301.6231(a)(5)-1T(d), Temporary Proced. & Admin. Regs.,

supra, to include the accuracy-related penalty within the

definition of the term "affected items", we are satisfied that

Congress intended for accuracy-related penalties to be treated

similarly to additions to tax; i.e., as affected items. See

Crystal Beach Dev. of Destin Ltd. v. Commissioner, T.C. Memo.

2000-170; H. Conf. Rept. 101-386, at 652 (1989).

In Crystal Beach Dev. of Destin Ltd. v. Commissioner, supra,

we noted that Congress recently amended section 6221 to provide

that the applicability of any penalty, addition to tax, or

additional amount that relates to an adjustment to a partnership

item shall be determined at the partnership level. See Taxpayer
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Relief Act of 1997, Pub. L. 105-34, sec. 1238(a), 111 Stat. 1026. 

However, the amendment to section 6221 is effective only for

partnership taxable years ending after August 5, 1997. See H.

Conf. Rept. 105-220, at 685 (1997) (effective for partnership

taxable years ending after the date of 

enactment-–August 5, 1997).

Consistent with the preceding discussion, it follows that

the Court lacks jurisdiction to review the applicability of the

accuracy-related penalties for Hatchery's taxable years ending in

1994, 1995, and 1996. These penalties may only be contested at

the individual shareholder level following the completion of

Hatchery's corporate level proceeding. Accordingly, we shall

grant respondent's Motion to Dismiss for Lack of Jurisdiction and

to Strike insofar as respondent moves to dismiss and strike

allegations in the Hatchery petition pertaining to the accuracyrelated penalties.

In view of the foregoing,

Appropriate orders

will be issued.