Case Name: Eastern States Casualty Agency, Inc., Wilma Smith, Tax Matters Person, Petitioner v. Commissioner of Internal Revunue, Respondent
Court: United States Tax Court
Jurisdiction: United States
Decision Date: 1991-06-04
Citations: 96 T.C. 773
Docket Number: Docket No. 3497-90
Parties: Eastern States Casualty Agency, Inc., Wilma Smith, Tax Matters Person, Petitioner v. Commissioner of Internal Revunue, Respondent
Judges: Chabot, Parker, Shields, Swift, Jacobs, Gerber, WRIGHT, WELLS, and HALPERN, JJ., agree with the majority.
Reporter: Reports of the Tax Court of the United States
Volume: 96
Pages: 773–792

Head Matter:
Eastern States Casualty Agency, Inc., Wilma Smith, Tax Matters Person, Petitioner v. Commissioner of Internal Revunue, Respondent
Docket No. 3497-90.
Filed June 4, 1991.
David M. Kuchinos, for the petitioner.
Keith C. Troxell, for the respondent.

Opinion:
OPINION
NlMS, Chief Judge:
This case is before the Court on petitioner's motion to dismiss for lack of jurisdiction. The issue for decision is whether an S corporation with four shareholders is excepted from the unified audit and litigation procedures contained in section 6241 et seq. (Unless otherwise indicated, section references are to the Internal Revenue Code as in effect for the year in issue.)
Background
In a notice of final S corporation administrative adjustment (FSAA) issued on December 20, 1989, respondent determined adjustments to the S corporation return filed by Eastern States Casualty Agency, Inc. (Eastern States), for the taxable year ending December 31, 1984. On February 26, 1990, petitioner, Wilma Smith, filed a timely petition for readjustment in her capacity as the tax matters person of Eastern States.
At the time of the filing of the petition herein, Eastern States had its principal place of business in Cherry Hill, New Jersey.
On April 23, 1990, respondent filed his answer to the petition.
On January 31, 1991, petitioner filed a motion to dismiss for lack of jurisdiction on the ground that the FSAA issued to Eastern States was invalid. On March 13, 1991, petitioner filed a memorandum in support of petitioner's motion to dismiss for lack of jurisdiction. Petitioner argues that sections 6244 and 6231(a)(1)(B) except Eastern States from the unified audit and litigation procedures contained in section 6241 et seq. because Eastern States had 10 or fewer shareholders during the year in issue. Petitioner finds support for her position in Arenjay Corp. v. Commissioner, 920 F.2d 269 (5th Cir. 1991), revg. and remanding an unreported order of this Court.
Respondent objects to petitioner's motion to dismiss and argues that the Court should continue to follow its decision in Blanco Investments & Land, Ltd. v. Commissioner, 89 T.C. 1169 (1987).
Because venue for an appeal of the instant case would lie with the U.S. Court of Appeals for the Third Circuit, Arenjay Corp. v. Commissioner, supra, is not controlling herein, and we respectfully decline to follow it for reasons hereinafter stated. See Golsen v. Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir. 1971). Nonetheless, the significance of the issue to the Court's jurisdiction compels us to reconsider our prior decisions at this time.
Discussion
The issue to be decided is whether the unified subchapter S audit and litigation procedures contained in section 6241 et seq. apply to Eastern States, an S corporation with four shareholders. If we conclude that the unified procedures do not apply, then the FSAA issued to Eastern States is invalid and we must dismiss this case for lack of jurisdiction.
Subchapter D of chapter 63 of subtitle F was codified by section 4(a) of the Subchapter S Revision Act of 1982, Pub. L. 97-354, 96 Stat. 1691-1692, and provides for the unified tax treatment of subchapter S items. Section 6241 provides that the tax treatment of subchapter S items generally will be determined in a unified manner at the corporate level as opposed to the shareholder level, except as otherwise provided by regulations.
The Secretary issued temporary regulations on January 27, 1987, providing that where an S corporation consists of five or fewer shareholders, the tax treatment shall not be determined at the corporate level. The temporary regulations, however, are applicable only to the taxable year of an S corporation, the due date of the return of which is on or after January 30, 1987. Sec. 301.6241-lT(c)(2)(i), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 3003 (Jan. 27, 1987). Here, we deal with adjustments for the taxable year ended June 30, 1984. By its terms, the temporary regulation is inapplicable to this case.
Pursuant to section 6244, many of the procedures for determining subchapter S items are borrowed from the unified partnership audit and litigation provisions contained in section 6221 et seq. The unified partnership procedures (subchapter C of chapter 63) were added to the Code by section 402 of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, 96 Stat. 648.
Section 6244 provides:
The provisions of—
(1) subchapter C which relate to—
(A) assessing deficiencies, and filing claims for credit or refund, with respect to partnership items, and
(B) judicial determination of partnership items, and
(2) so much of the other provisions of this subtitle as relate to
partnership items,
are (except to the extent modified or made inapplicable in regulations) hereby extended to and made applicable to subchapter S items.
Thus, the partnership provisions relating to assessing deficiencies, filing claims for credit or refund, and judicial determinations, as well as other provisions relating to partnership items, generally are made applicable to subchapter S items.
Section 6231(a)(1)(B) provides that partnerships with 10 or fewer partners are excepted from the unified partnership audit and litigation procedures contained in section 6221 et seq. The tax treatment of such "small" partnerships is determined at the partner level.
Petitioner argues that the small partnership exception contained in section 6231(a)(1)(B) is grafted onto the unified subchapter S procedures by section 6244 so that S corporations with 10 or fewer shareholders are excepted from the unified procedures. Because Eastern States had but four shareholders during 1984, petitioner argues that the FSAA issued in this case is invalid.
Respondent contends that we should continue to follow our decision in Blanco Investments & Land, Ltd. v. Commissioner, supra. In Blanco, we stated:
Section 6244 incorporates generically four categories of partnership audit and litigation provisions into the S corporation audit and litigation procedures: those relating to (1) assessments of deficiencies, (2) filing claims for credit or refund, (3) judicial determinations of partnership items, and (4) partnership items. Section 6231(a)(1)(B) [defining a partnership for TEFRA purposes] does not relate to an assessment, refund claim, or judicial determination and, therefore, is not made applicable to S corporation audits by section 6244(1). Consequently, the small partnership exception applies to S corporation litigation only if it "relate[s] to partnership items" within the meaning of section 6244(2). [Blanco Investments & Land, Ltd. v. Commissioner, supra at 1173. Fn. ref. omitted.]
We accordingly refused to accept the taxpayer's contention that the 10-person partnership exception was incorporated by section 6244(1) into the subchapter S corporation procedures. We went on, however, to hold that there was an exception applicable to S corporation audit and litigation procedures if it related to "partnership items" within the meaning of section 6244(2). As we noted in Blanco:
We believe that the small partnership exception does, by definition, "relate" to partnership items. Eligibility for small partnership status turns, in part, on how the partners share partnership items. Section 6231(a)(l)(B)(i)(II) expressly provides that a necessary element of small partnership status is that each partner share in partnership items in the same proportion as that partner shares in all other items. Further, the existence of partnership items depends on the existence of a partnership. If a partnership meets the requirements for the small partnership exception of section 6231(a)(1)(B), it is not considered to be a partnership for purposes of the partnership litigation procedures. In that event, no partnership items exist. The connection, therefore, between the small partnership exception and partnership items is direct and substantial. [Blanco Investments & Land, Ltd. v. Commissioner, supra at 1174.]
We followed our holding in Blanco in 111 West 16 St. Owners, Inc. v. Commissioner, 90 T.C. 1243 (1988). Specifically, we rejected the taxpayer's argument that an S corporation having 10 or fewer shareholders during 1983 was excepted from the unified subchapter S procedures as a small S corporation. Again, we concluded that in the absence of effective regulations on the point, we would not extend the small S corporation exception beyond S corporations with one shareholder. 90 T.C. at 1247. Because the S corporation in 111 West had three shareholders, we held that the FSAA issued in that case was valid and denied the taxpayer's motion to dismiss. 90 T.C. at 1248. Our rationale in deciding Blanco and 111 West was subsequently rejected by the U.S. District Court for the Northern District of Georgia in Miller v. United States, 710 F. Supp. 1377 (N.D. Ga. 1989). The District Court disagreed with our holding in Blanco that the exception for small partnerships related to partnership items as contemplated in section 6244(2). The District Court stated:
Section 6244 makes applicable to subchapter S "items" only those provisions that "relate to partnership items." The small partnership provision defines the class of partnerships that are exempt from taxation at the partnership level. The provision turns in part on how the partners share partnership items, but the provision itself is applicable only after the partnership items have been identified. The Court therefore concludes that the definition of a small partnership does not "relate to partnership items" in a manner that would make the provision "applicable to subchapter S items" under §6244. [Miller v. United States, supra at 1379-1380.]
Further, the District Court examined the legislative history of the Subchapter S Revision Act of 1982 and found no evidence of congressional intent to incorporate the definition of the class of exempt partnerships into a definition of a class of exempt S corporations. Miller v. United States, supra at 1380. On these grounds, the District Court held that the FSAA relating to taxable years 1983 through 1985 and issued with respect to an S corporation with three shareholders was valid.
We have reconsidered the "partnership item" aspect of our holding in Blanco, and upon reconsideration, believe we were incorrect in our view that the 10-person exception has any relation to "partnership items." Rather, that term relates to the provisions of section 6231(a)(3) which define partnership items. That subsection provides:
(3) Partnership item. — The term "partnership item" means, with respect to a partnership, any item required to be taken into account for the partnership's taxable year under any provision of subtitle A to the extent regulations prescribed by the Secretary provide that, for purposes of this subtitle, such item is more appropriately determined at the partnership level than at the partner level.
In our view, the definition of what relates to a partnership item refers to items of income, deductions, and credits of partnerships, rather than to what constitutes a partnership for TEFRA purposes. In the conference committee report, it is stated: "the tax treatment of items of partnership income, loss, deductions, and credits will be determined at the partnership level in a unified partnership proceeding rather than in separate proceedings with the partners." H. Rept. 97-760 (Conf.) (1982), 1982-2 C.B. 662. Thus, it is clear that Congress, by utilizing the term "partnership items," intended it to mean items of income, loss, deductions, and credits. We do not believe that Congress intended it to incorporate the 10-person exception for small partnerships within the ambit of that term.
More recently, our decisions in Blanco and 111 West were criticized in Arenjay Corp. v. Commissioner, 920 F.2d 269 (5th Cir. 1991), revg. and remanding an unreported order of this Court, although on different grounds than those articulated by the District Court in Miller. In Arenjay, the taxpayer had argued in this Court that an S corporation with four shareholders was excepted from the unified subchapter S procedures and that therefore its case should be dismissed. Relying on Blanco and 111 West, we denied the taxpayer's motion to dismiss in an unpublished order.
In analyzing the issue, the appellate court disagreed with our prior decisions to the extent that we had limited the small S corporation exception to S corporations with one shareholder. The appellate court concluded that the clear statutory directive mandated an application of the small S corporation exception to S corporations with 10 or fewer shareholders so as to mirror the small partnership exception. Arenjay Corp. v. Commissioner; supra at 271. As a consequence, the appellate court reversed and remanded our order.
We first note that the general definition of a partnership under TEFRA is contained in section 6231(a)(1)(A), which provides:
(A) In general. — Except as provided in subparagraph (B), the term "partnership" means any partnership required to file a return under section 6031(a).
As previously discussed, section 6231(a)(1)(B) sets forth an exception for small partnerships with 10 or fewer partners.
In contrast, the definition of an S corporation is contained in section 1361(a). This definition was amended, contemporaneously with the enactment of the unified subchapter S procedures, so as to increase the maximum permissible number of shareholders of an S corporation from 25 to 35. See sec. 2 of the Subchapter S Revision Act of 1982, Pub. L. 97-354, 96 Stat. 1669. Despite this change, neither section 1361 nor section 6244 contains an express exception for a "small" subchapter S corporation. Moreover, as we recognized in Blanco Investments & Land, Ltd. v. Commissioner, 89 T.C. at 1174, "No specific expression of congressional approval or disapproval of a small subchapter S exception can be found."
Petitioner asserts that, contrary to our statement in Blanco, the legislative history of the Subchapter S Revision Act of 1982 supports her contention that Congress intended for the small partnership exception to be directly grafted onto the unified subchapter S procedures. Specifically, petitioner cites S. Rept. 97-640, 1982-2 C.B. 718, 729, which states:
The audit provisions are to generally follow the new audit provisions made applicable to partnerships by the Tax Equity and Fiscal Responsibility Act of 1982. Thus, for example, rules relating to restrictions on assessing deficiencies, periods of limitations, and judicial review will follow the corresponding partnership rules. However, those rules may be modified by Treasury regulations where appropriate to take account of the differences (whether or not tax related) between a corporation and a partnership.
We do not agree with petitioner that the preceding statement supports her interpretation of section 6244.
We note that petitioner quotes only a portion of the language of the Senate report which is material to the issue at hand. The relevant language of the Senate report which petitioner disregards states:
Explanation of Provision (secs. 6241-6245)
Under the bill, the tax treatment of items of subchapter S income, loss, deductions, and credits generally will be determined at the corporate level in a unified proceeding rather than in separate proceedings with shareholders. Shareholders will be given notice of any administrative or judicial proceeding at which such items will be determined. Further, each shareholder will be given the opportunity to participate in these proceedings. [S. Rept. 97-640, 1982-2 C.B. at 729. Emphasis added.]
Petitioner's reliance on the limited language quoted in her memorandum is misplaced. In particular, by disregarding the language immediately quoted above, petitioner avoids consideration of the import of section 6241 which provides:
Except as otherwise provided in regulations prescribed by the Secretary, the tax treatment of any subchapter S item shall be determined at the corporate level. [Emphasis added.]
As we understand the plain language of section 6241, Congress vested the Secretary with the absolute discretion to issue regulations excepting S corporations from the unified procedures.
We contrast the language of section 6241 with section 6221 of the unified partnership procedures which provides:
Except as otherwise provided in this subchapter, the tax treatment of any partnership item shall be determined at the partnership level. [Emphasis added.]
A plain reading of this provision reveals that the Secretary has no discretion to except partnerships from the unified procedures. Rather, Congress itself provided the exception for small partnerships as described in section 6231(a)(1)(B). (Compare sections 6231(a)(3) and 6245, which vest the Secretary with discretion to prescribe which items are more appropriately determined at the partnership or S corporation level as opposed to the partner or shareholder level.)
Having established that section 6241 provides the Secretary with discretion to except S corporations from the unified procedures, we necessarily must question whether Congress intended to limit or revoke that discretion by grafting section 6231(a)(1)(B) onto the unified subchapter S procedures by means of section 6244. To the contrary, as the District Court concluded in Miller v. United States, 710 F. Supp. at 1380, section 6244 is reasonably read to provide for a limited application of partnership procedural provisions in the context of the unified subchapter S procedures. See Gold-N-Travel, Inc. v. Commissioner, 93 T.C. 618 (1989) (partnership rules regarding designation of a tax matters person are applicable under the unified subchapter S procedures).
Viewing the unified subchapter S procedures as a whole, section 6241, rather than section 6244, provides the most direct and explicit authority for the Secretary to prescribe, within his discretion, a small S corporation exception. By its express terms, section 6241 requires that subchapter S items be determined under the unified procedures unless the Secretary directs otherwise. Furthermore, we note that the Secretary cited section 6241 as authority for section 301.6241-lT(c)(2)(ii), Temporary Proced. & Admin. Regs., supra, which prescribes an exception effective on or after January 30, 1987, for S corporations with five or fewer shareholders, see T.D. 8122, 1987-1 C.B. 342, and was silent as to section 6244 as authority for the temporary regulation.
Our broad application of section 6244 in Blanco, as well as that of the Fifth Circuit in Arenjay, serves to render section 6241 meaningless. This is particularly so when section 6241 is read in conjunction with section 6245 (subchapter S item defined). Further, the respective decisions . excepting S corporations with 1 and 10 shareholders from the unified procedures defeat the Secretary's decision to decline to extend any exception to S corporations retroactively from January 30, 1987.
As a consequence of the foregoing, we are now convinced that we were incorrect in concluding in Blanco that section 6244(2) was intended to graft onto the unified subchapter S procedures the definition of a small partnership as provided in section 6231(a)(1)(B). We find no support for our presumption in that case that Congress intended to directly incorporate a small S corporation exception in the unified subchapter S procedures through section 6244(2).
We note that in Blanco, a one-shareholder subchapter S corporation, we went on to state an additional reason for our holding:
it is clear that interpreting the S corporation litigation procedures to apply to an S corporation with one shareholder would lead to a result contrary to the intent of the statute. The procedures were intended to conserve time and resources by disposing of all issues relating to an S corporation in a single proceeding. There is no need for a separate entity level proceeding for an S corporation with only one shareholder. It is impossible to have conflicting shareholder positions with a single shareholder. The judicial and administrative problems that prompted Congress to enact the entity level audit and litigation procedures do not exist in the case of the single shareholder. Moreover, applying the entity level procedures to a single shareholder S corporation creates additional litigation rather than conserving time and resources. [Blanco Investments & Land, Ltd. v. Commissioner, supra at 1176.]
The Fifth Circuit in Arenjay questioned this "practical" approach, and upon reconsideration, we also determine that we will not follow this holding in Blanco. There are no exceptions written into the statutory language for subchapter S corporations based upon the number of shareholders. Congress has chosen to leave the question of exceptions to the discretion of the Secretary.
Thus, we will no longer follow Blanco and 111 West. Rather, we conclude that there was no small S corporation exception to the unified S corporation procedures prior to January 30, 1987, the effective date of section 301.6241-lT(c), Temporary Proced. & Admin. Regs. Furthermore, for the reasons stated, we respectfully decline to follow the Fifth Circuit's decision in Arenjay Corp. v. Commissioner, supra.
Accordingly, we hold that respondent properly issued an FSAA to Eastern States. Petitioner's motion to dismiss for lack of jurisdiction will be denied.
An appropriate order will be issued.
Reviewed by the Court.
Chabot, Parker, Shields, Swift, Jacobs, Gerber, WRIGHT, WELLS, and HALPERN, JJ., agree with the majority.
Hamblen, Clapp, Parr, and Beghe, JJ., concur in the result only.
RUWE, J., did not participate in the consideration of this opinion.