petaluma fx partners llc ronald scott vanderbeek a partner other than the tax_matters_partner petitioner v commissioner of internal revenue respondent docket no filed date on remand we are instructed by the court_of_appeals for the district of columbia circuit to determine whether we have jurisdiction to determine whether a penalty under sec_6662 i r c is applicable in this partnership-level case 591_f3d_649 d c cir affg in part revg in part and vacating in part 131_tc_84 held applying the instructions set forth in the court of appeals’ opinion we do not have jurisdic- tion over any sec_6662 i r c penalty determination in this case edward m robbins jr for petitioner gerald a thorpe and jason m kuratnick for respondent supplemental opinion goeke judge this matter is before the court on remand from the court_of_appeals for the district of columbia cir- cuit for further proceedings consistent with its opinion in 591_f3d_649 d c cir affg in part revg in part and vacating in part 131_tc_84 the issue for decision on remand is whether this court has jurisdiction over the determination in respondent’s notice of final_partnership_administrative_adjustment fpaa issued to petitioner and other partners that all of the underpayments of tax resulting from adjust- ments of partnership items are attributable to gross or substantial valuation misstatements penalized under sec_6662 b e and h negligence or disregard of rules or regulations penalized under sec_6662 b and c or substantial understatements of income_tax penalized under sec_6662 b and d this opinion supplements our prior opinion 131_tc_84 affd in part revd in part and vacated in part 591_f3d_649 d c cir unless otherwise indicated all section references are to the internal_revenue_code in effect for the year in issue verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila united_states tax_court reports background we summarize relevant background from 131_tc_84 petaluma i and set forth additional details for purposes of deciding the issue on remand the dispute in this case relates to an fpaa issued to peti- tioner and other partners of petaluma fx partners llc petaluma or the partnership on date in the fpaa respondent made the following adjustments to items reported on petaluma’s partnership return for its tax_year and to outside bases of all the partners items not reported on the return item as reported as corrected capital contributions distributions-property other than money outside partnership bases distributions-money other income tax-exempt_interest income assets-cash liabilities and capital- other current liabilities partners’ capital accounts dollar_figure big_number big_number big_number big_number big_number big_number big_number -0- -0- -0- -0- -0- -0- -0- -0- the penalty none of the above items result in computational adjustments as defined in sec_6231 to the partners’ tax liabil- ities petitioner has previously stipulated that substantive issues over which the court has jurisdiction will not be con- tested petitioner reserved for valuation misstatement from his concession but the court_of_appeals has held that we do not have jurisdiction over that penalty petaluma fx partners llc v commissioner f 3d pincite form 4605-a examination changes-partnerships fiduciaries s_corporations and interest charge domestic international sales corporations attached to the fpaa states i r c penalty sec_6662 is applicable at the indi- vidual partner level and may be raised in separate pro- ceedings at the partner level following the present partner- ship proceeding this court issued petaluma i on date holding that it had jurisdiction to decide that petaluma should be disregarded for tax purposes that the partners had no verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila petaluma fx partners llc v commissioner bases in their interests in the partnership since the partner- ship was disregarded and that a valuation_misstatement_penalty under sec_6662 applied petaluma i t c pincite the court_of_appeals affirmed our determination that we had jurisdiction to decide whether the partnership should be disregarded however in this partnership-level case it reversed our determination regarding partners’ out- side bases holding that we did not have jurisdiction the court_of_appeals remanded the case for a determination of whether this court has jurisdiction over any penalties under sec_6662 petaluma fx partners llc v commissioner f 3d pincite discussion applying the mandate to reconsider whether we have juris- diction over any sec_6662 penalties we conclude as explained herein that this court lacks jurisdiction over the penalty issues in this partnership-level proceeding after the court_of_appeals issued the mandate we ordered the parties to state their respective positions regarding the issues on remand and both parties have complied there being no need for trial or further hearing we review the par- ties’ respective positions in the light of the opinion of the court_of_appeals i tefra in general under the tax equity and fiscal responsibility act of tefra all partnership items are determined in a single partnership-level proceeding sec_6226 see also 64_f3d_101 2d cir in a partnership-level proceeding the court’s jurisdiction is lim- ited by sec_6226 sec_6226 scope of judicial review -a court with which a peti- tion is filed in accordance with this section shall have jurisdiction to deter- mine all partnership items of the partnership for the partnership taxable_year to which the notice of final_partnership_administrative_adjustment relates the proper allocation of such items among the partners and the applicability of any penalty addition_to_tax or additional_amount which relates to an adjustment to a partnership_item sec_6231 defines the terms partnership_item non- partnership_item and affected_item verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila united_states tax_court reports 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 partner- ship level than at the partner level nonpartnership item -the term nonpartnership item means an item which is or is treated as not a partnership_item affected_item -the term affected_item means any item to the extent such item is affected by a partnership_item an affected_item is by definition not a partnership_item 127_tc_75 see also 95_tc_1 this distinction is important in the present case as affected items generally will involve issuance of notices of deficiency to indi- vidual partners described as partner-level proceedings ii petitioner’s position petitioner first argues that this court lacks jurisdiction to determine the amounts of any penalties in this partnership- level proceeding because no penalty relates to an adjustment to a partnership_item under sec_6226 petitioner main- tains no underpayment arises as a result of any partnership_item because there is no computational deficiency adjustment at the partner level as a result of our holding that petaluma is to be disregarded for tax purposes petitioner contends that in the light of the court of appeals’ holding that this court lacks jurisdiction to determine outside_basis there is no deficiency or underpayment_of_tax within the jurisdiction of this court in respect of which a penalty can be held to apply petitioner also argues that because the partnership is a nullity no partnership_item could create a deficiency or underpayment to which penalties could apply therefore any penalty does not relate to an adjustment to a partnership_item and any penalty is an item which must be determined with a statutory_notice_of_deficiency iii respondent’s position respondent argues that this court has jurisdiction to determine the gross_valuation_misstatement penalty because sec_6221 sec_6226 and the applicability of verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila petaluma fx partners llc v commissioner a give this court jurisdiction to determine penalties related to partnership items respondent contends the pen- alty relates to two partnership items-the shamming of the partnership which the court_of_appeals affirmed as the determination of a partnership_item and the amounts of the purported partners’ contributions to the partnership iv court of appeals’ opinion the court_of_appeals held that this court had no jurisdic- tion to determine that the outside bases of petaluma’s part- ners were zero as outside_basis is an affected_item not a partnership_item the court_of_appeals then held inasmuch as this court lacked jurisdiction over outside_basis that the court also lacked jurisdiction to determine that sec_6662 penalties apply with respect to outside_basis because those penalties did not relate to a partnership_item with respect to other sec_6662 penalties the court_of_appeals vacated our decision and remanded the case to this court stating while it may be that some penalties could have been assessed without partner-level computations we cannot affirm a decision that has not yet been made therefore we vacate the opinion of the tax_court on the pen- alties imposition and computation it may be that upon remand a deter- mination can be made for some portion of the penalties but neither party has briefed that question before us petaluma fx partners llc v commissioner f 3d pincite we must now decide whether we have jurisdiction to deter- mine at the partnership level whether any of the sec_6662 penalties apply v sec_6662 the penalties about which jurisdiction is in question all arise under sec_6662 the general_rule is that if the section applies to any portion of an underpayment_of_tax percent of that portion will be added as a penalty in the case of a gross_valuation_misstatement under sec_6662 the 20-percent penalty is increased to percent sec_6662 describes the circumstances when the section shall apply and the penalty is triggered respondent asserts three of those circumstances apply in this case and also asserts all three relate to partnership-level determinations they are neg- verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila united_states tax_court reports ligence under sec_6662 and c substantial under- statement of income_tax under sec_6662 and d and gross or substantial_valuation_misstatement under sec_6662 e and h the court_of_appeals has agreed with petitioner’s position that this court lacks jurisdiction over penalties that apply with respect to outside_basis because those penalties do not relate to partnership_item adjust- ments there is a question whether outside_basis is the cor- rect term because the partnership has been held to be a sham but there clearly are adjustments at the partner level that will relate to the partners’ bases in assets that they sold we are directed that such adjustments are beyond our jurisdiction and the related penalties are also see petaluma fx partners llc v commissioner f 3d pincite petaluma argues that since the tax_court lacked jurisdic- tion to determine outside_basis it also lacks jurisdiction to determine that penalties apply with respect to outside_basis because those penalties do not relate to an adjustment to a partnership_item we agree vi analysis in this case none of the fpaa adjustments are items that flow directly to the partner-level deficiency computation as computational adjustments any deficiencies must therefore be determined against the partners as affected items and must be resolved in separate partner-level deficiency proce- dures the sec_6662 penalties are all related to these adjustments which have not yet been made by respondent the court of appeals’ decision addressed the penalty for remand substantial_valuation_misstatement but respondent asserts in this partnership-level proceeding that we have jurisdiction to determine the applicability of the percent penalty under sec_6662 and b for neg- ligence on account of our determination that the partnership is a sham respondent does not offer any other issue before us where a penalty under any subsection of sec_6662 could be applied to an adjustment to a specific partnership- level item we can find none in the fpaa the pleadings or the stipulation of settled issues on the determination that the partnership is a sham implies negligent conduct regarding formation of the partnership but verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila petaluma fx partners llc v commissioner in this case that determination does not trigger a computa- tional adjustment to taxable_income of the partners the court_of_appeals declined to allow the general effect of the partnership determination of sham to confer jurisdiction of the penalty relating to valuation because the valuation related to outside_basis an affected_item the court_of_appeals instructs that for us to have jurisdiction over a pen- alty at the partnership level it must ‘ relate to an adjust- ment to a partnership_item ’ petaluma fx partners llc v commissioner f 3d pincite quoting sec_6226 it must also be capable of being computed without partner- level proceedings id leading at least potentially to only a computational adjustment to the partners’ returns the effect of the mandate concerning the sec_6662 penalty is that if the penalty does not relate directly to a numerical adjust- ment to a partnership_item it is beyond our jurisdiction in this case there are no such adjustments to which a penalty can apply the adjustment is an affected_item the sham determination in this case only indirectly affects basis at the partner level there is no partnership_item flowing through to the partners’ returns as a computational adjustment therefore in accordance with the opinion of the court_of_appeals we conclude that we do not have jurisdiction over any sec_6662 penalty determinations in this partnership- level case an appropriate order and decision will be entered reviewed by the court colvin wells thornton wherry kroupa and holmes jj agree with this majority opinion gustafson and morrison jj did not participate in the consideration of this opinion halpern j dissenting in 131_tc_84 affd in part revd in part and vacated in part 591_f3d_649 d c cir we held that if a partnership is disregarded for tax purposes we have jurisdiction to treat the partners’ outside bases as zero we added if a property has a basis of zero any basis verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila united_states tax_court reports claimed above that will be a valuation_overstatement and the sec_6662 accuracy-related_penalty will apply id while the court_of_appeals agreed that in this partnership-level proceeding we have jurisdiction to disregard petaluma as a partnership it disagreed that on account thereof we can find that the partners overstated the value of their bases in petaluma petaluma fx partners llc v commissioner f 3d pincite it faulted our determination that the partners overstated their bases thus possibly attracting a valuation_misstatement_penalty on the ground that outside_basis is an affected_item which we lack jurisdiction to determine in this partnership-level proceeding id it questioned whether the accuracy-related_penalty could have been computed without partner-level proceedings to determine the affected-items questions concerning outside bases id pincite it specu- lated whether any penalty could be assessed without partner-level computations and it remanded for us to again consider the penalty id pincite the majority concludes that we do not have jurisdiction over any sec_6662 penalty determinations in this partnership-level case majority op p i disagree sec_6226 establishes our jurisdiction in a partner- ship-level proceeding to determine the applicability of pen- alties that relate to adjustments to partnership items respondent claims that we have adjusted partnership items in this partnership-level proceeding by disregarding petaluma as a partnership and by redetermining the amounts of the putative partners’ contributions to it because of those adjustments respondent asks that we sustain his assertion of the accuracy-related_penalty imposed by sec_6662 that penalty is an ad valorem addition imposed on the portion of an underpayment_of_tax to which the section applies required to be shown on a tax_return see sec_6662 in this case the relevant tax returns and underpay- ments are those of petaluma’s putative partners because although it filed a tax_return petaluma did so as a partner- ship which is a passthrough_entity that pays no income_tax see sec_701 respondent’s position is that the putative part- ners underpaid their income taxes because of adjustments to partnership items made by this court and that some or all of those underpayments are attributable to one or more of three of the circumstances specified in sec_6662 neg- verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila petaluma fx partners llc v commissioner ligence or disregard of rules and regulations without distinc- tion negligence a substantial_understatement_of_income_tax and a substantial or gross_valuation_misstatement see sec_6662 and the term affected_item includes penalties such as the sec_6662 accuracy-related_penalty when the penalty is imposed on a partner with respect to an adjustment to a partnership_item and the penalty is computed with reference to the portion of an underpayment in tax attributable to the adjustment see sec_301_6231_a_5_-1t d temporary proced admin regs fed reg date currently sec_301_6231_a_5_-1 proced admin regs the penalty may be applicable here if petaluma is disregarded as a partnership or each putative partner’s con- tribution to petaluma is deemed to be zero one or more items on each putative partner’s return will change likely resulting in a net increase in his tax_liability and concomi- tant underpayment of the tax required to be shown on his return if in this proceeding we determine that one or more of the sec_6662 through circumstances exist with respect to an adjustment to a partnership_item then we should sustain respondent’s determination that the penalty applies the penalty is an affected_item and each putative partner’s liability for the penalty is determined by way of a computational adjustment see sec_301_6231_a_6_-1t a temporary proced admin regs fed reg date currently sec_301_6231_a_6_-1 proced admin regs our decision that the penalty applies is nec- essarily preliminary however since we lack jurisdiction in this partnership-level proceeding to determine any partner’s tax_liability or underpayment_of_tax in petaluma fx partners llc v commissioner t c pincite we concluded that the accuracy-related_penalty applied on the ground of a valuation misstatement of outside_basis we saw no need to address whether the penalty could be applied on the grounds of negligence or understatement of income_tax id pincite as stated the court_of_appeals reversed our penalty decision on the ground that outside_basis is an affected_item over which in this proceeding we i conclude the results are likely only because i lack information about the particulars of the putative partners’ returns and tax_liabilities verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila united_states tax_court reports lack jurisdiction it questioned whether the accuracy-related_penalty based on a valuation misstatement could be com- puted without partner-level proceedings to determine the affected-items questions concerning outside bases petaluma fx partners llc v commissioner f 3d pincite it speculated whether any penalty could be assessed without partner-level computations id pincite respondent answers the specific question posed by the court_of_appeals in the affirmative arguing alternatively that the overvaluation penalty applies to any under- payment of tax that results from the determination that the partnership is a sham and that it applies because it relates to adjustments to inside_basis in the contributed options with respect to his first alternative respondent adds the court can do this determine the application of the penalty without determining each partner’s outside_basis respondent adds that as an alternative to imposing the accuracy-related_penalty on the ground of a valuation misstatement the court could impose the penalty on the ground of negligence or a substantial_understatement_of_income_tax the majority believes that it cannot impose any accuracy- related penalty because any deficiencies in tax resulting from this proceeding must therefore be determined against the partners as affected items and must be resolved in separate partner-level deficiency procedures the sec_6662 pen- alties are all related to these adjustments which have not yet been made by respondent majority op p while it is true that the accuracy-related_penalty is an ad valorem addition based on an underpayment_of_tax which in the case of adjustments to partnership items may be indeterminable without a partner-level determination respondent is here claiming that the proximate cause of any underpayment resulting from our adjustments to partnership items is either a partnership-level misstatement of value partnership-level negligence or the adjustments themselves which will result in a substantial_understatement_of_income_tax the majority appears to accept respondent’s claim of proximate cause the determination that the partnership is a sham implies negligent conduct regarding formation of the partnership majority op p nevertheless it reads the court of appeals’ questioning of whether a valuation misstatement verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila petaluma fx partners llc v commissioner could be computed without partner-level proceedings to determine outside_basis as establishing a limiting rule that for us to have penalty jurisdiction at the partnership level not only must the penalty relate to a partnership_item as plainly required by sec_6226 but the penalty also must be capable of being ‘computed without partner- level proceedings ’ leading at least potentially to only a computational adjustment to the partners’ returns majority op p since the accuracy-related_penalty is an ad valorem addition determinable only at the taxpayer in this case partner level what the majority must mean is that a computational adjustment establishing a partner’s liability for the penalty must be achievable without the necessity of any partner-level determination the majority adds the effect of the mandate concerning the sec_6662 penalty is that if the penalty does not relate directly to a numerical adjustment to a partnership_item it is beyond our jurisdiction majority op p finding no such adjust- ments the majority concludes we have no penalty jurisdic- tion in this case majority op p the court_of_appeals does not mention numerical adjust- ments and it speaks about the inability to compute the accuracy-related_penalty without partner-level proceedings only in the context of our attempt to impose the penalty on account of a valuation misstatement of an affected_item ie outside_basis respondent claims that there are grounds for the penalty that do not require us to determine an affected_item other than the penalty itself while the court_of_appeals does speculate whether a penalty could have been assessed without a partner-level computation both the com- putational adjustment and assessment of any penalty liability relating to a partnership_item are administrative steps taken only after the close of the partnership-level pro- ceeding see sec_6225 sec_301_6231_a_6_-1t a tem- porary proced admin regs supra currently sec_301_6231_a_6_-1 proced admin regs moreover the term partner level determination is used in sec_301_6231_a_6_-1t a temporary proced admin regs fed reg date currently sec_301_6231_a_6_-1 proced admin regs to describe an intermediate partner-level determination that in some cases may be necessary before a change in a partner’s tax_liability to reflect the treatment of a partnership_item can be made by way of a computational adjustment the majority appears to assume that the penalties here in issue cannot be determined without partner-level deter- minations verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila united_states tax_court reports the regulations are clear that a penalty related to a partner- ship item may be directly assessed following the partnership- level proceeding based on determinations in that proceeding regardless of whether partner level determinations are required sec_301_6231_a_6_-1t a temporary proced admin regs supra currently sec_301 a - a proced admin regs the majority’s attribution to the court_of_appeals of a rule that a computational adjust- ment to reflect a penalty must be achievable without the necessity of any partner-level determination flies directly in the face of other language in that same regulation which distinguishes computational adjustments with respect to pen- alties from other computational adjustments requiring partner-level determinations however if a change in a partner’s tax_liability cannot be made without making one or more partner level determinations that portion of the change in tax_liability attributable to the partner level determinations shall be made under the provisions of subchapter_b of chapter of the internal_revenue_code relating to deficiency procedures except for any penalty addition_to_tax or additional_amount which relates to an adjust- ment to a partnership_item supra supplied emphasis sec_301_6231_a_6_-1t a temporary proced admin regs sec_301_6231_a_6_-1 proced admin regs the court_of_appeals did not undertake to reorganize the procedural steps established by congress and implemented by the secretary for determining computing assessing and collecting pen- alties related to partnership items nor should we interpret it as doing so currently we obey the court_of_appeals mandate by reconsidering the sec_6662 penalty on grounds such as those claimed by respondent other than those such as the putative part- ners’ outside bases that depend on our determination of an affected_item our task even if we determine that the pen- alty applies is necessarily inconclusive since the penalty is an affected_item the amount of which is to be determined by computational adjustment which may as a preceding step require one or more partner-level determinations our juris- diction extends to the aspects of the penalty we are author- ized to determine nevertheless in exercise of that jurisdic- verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila petaluma fx partners llc v commissioner tion we may have to ask respondent to better explain the grounds he claims justify the penalty marvel j dissenting the court_of_appeals for the dis- trict of columbia circuit remanded this case for consider- ation of whether in this partnership-level proceeding we have jurisdiction over some portion of the penalties see 591_f3d_649 d c cir petaluma ii affg in part revg in part vacating petaluma i the majority concludes that we do not majority op p because i believe that the result the majority reaches is contrary to sec_6221 and sec_6226 as amended by the taxpayer_relief_act_of_1997 tra publaw_105_34 111_stat_1026 i respectfully dissent in part and remanding 131_tc_84 i the court_of_appeals opinion in petaluma i we held among other things that we had jurisdiction to decide whether the partnership used to achieve the challenged tax benefits was a sham and or lacked economic_substance we also had jurisdiction to decide that the partners’ outside bases were overstated because the partners could not have bases in a disregarded or sham part- nership we had jurisdiction over the sec_6662 accuracy-related_penalty because sec_6226 gave us jurisdiction to determine the applicability of any penalty addition_to_tax or additional_amount which relates to an adjustment to a partnership_item and a 40-percent accuracy-related_penalty attributable to the gross_valuation_misstatement of the partners’ outside bases applied see petaluma i t c pincite in petaluma ii the court_of_appeals for the district of columbia circuit affirmed our holding in but reversed our holdings in and and vacated and remanded on the penalties ques- tion see petaluma ii f 3d pincite the court_of_appeals stated as follows although we held we had jurisdiction over the sec_6662 accuracy-related_penalty we did not reach the issue of the applicability of any components other than the gross_valuation_misstatement component see petaluma i t c pincite verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila united_states tax_court reports as it is not clear from the opinion the record or the arguments before this court that the penalties asserted by the commissioner and ordered by the tax_court could have been computed without partner-level proceedings to determine the affected-items questions concerning outside bases we are unable to uphold the court’s determination of the penalty issues while it may be that some penalties could have been assessed without partner-level computations we cannot affirm a decision that has not yet been made therefore we vacate the opinion of the tax_court on the penalties imposi- tion and computation it may be that upon remand a determination can be made for some portion of the penalties but neither party has briefed that question before us id pincite the court_of_appeals remanded on the penalties question because it was not clear that the penalties asserted by the commissioner and ordered by the tax_court could have been computed without partner-level proceedings to determine the affected-items questions concerning outside bases id the court_of_appeals acknowledged the possibility that on remand a determination could be made for some portion of the penalties id pincite ii the sec_6662 penalty in petaluma a in general although respondent’s primary argument under sec_6662 is that a 40-percent accuracy-related_penalty applies because of a gross_valuation_misstatement he also asserted in the fpaa a 20-percent accuracy-related_penalty attrib- utable to negligence or to a substantial_understatement_of_income_tax the application of any of these components of the accuracy-related_penalty involves the juxtaposition of sec_6662 the tax equity and fiscal responsibility act of tefra publaw_97_248 96_stat_648 and amend- ments to tefra by tra to better understand the scope of our jurisdiction over the sec_6662 penalty in partner- ship-level tefra cases an overview of tefra and the tra amendments is helpful b tefra litigation structure before partnership tax issues were raised and liti- gated at the partner level resulting in bloated caseloads and duplicative litigation of partnership issues see 129_tc_11 affd in part and remanded in part on other grounds sub nom desmet v verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila petaluma fx partners llc v commissioner commissioner 581_f3d_297 6th cir in an effort to eliminate the perceived inefficiencies the waste of resources and the potential for inconsistent results among partners on the same partnership issues that could result from duplica- tive litigation at the partner level congress at the depart- ment of the treasury’s request enacted the unified partner- ship audit and litigation provisions as part of tefra see id the provisions were constructed around a simple premise- although a partnership is not an entity that is liable for fed- eral income_tax partnership tax issues ordinarily must be resolved in a single proceeding at the partnership level see id pincite the basic structure of partnership litigation under tefra is easy to understand sec_6221 provides that the tax treatment of any partnership_item shall be determined at the partnership level sec_6222 provides that a partner on the partner’s return shall treat a partnership_item in a manner consistent with the treatment of the item on the partnership return if the commissioner audits the partnership return and determines that adjustments to part- nership items are necessary he must issue an fpaa to the partnership through the tax_matters_partner and send a copy of the fpaa to all partners who are entitled to notice see sec_6223 the tax_matters_partner or a partner partners with a large enough partnership_interest may file a petition for judicial review of the fpaa within certain time limits sec_6226 and b a court with which a petition is filed has jurisdiction to determine all partnership items of the partnership for the partnership taxable_year to which the fpaa relates and the proper allocation of such items among the partners sec_6226 i r c before amendment by tra after the restrictions on assessment and collection under sec_6225 no longer apply the commissioner is authorized partnership items are items required to be taken into account for the partnership’s taxable_year to the extent that those items are more appropriately determined at the partnership level than at the partner level see sec_6231 nonpartnership_items that are affected by adjust- ments to partnership items are called affected items sec_6231 there are two types of affected items items that require factual determinations to be made at the partner level and items that require merely a computational adjustment such as the amount of a medical_expense_deduction under sec_213 see n c f energy partners v commissio89_tc_741 the former group the substantive affected items has not only a computa- tional element but also a substantive element in that a court must consider evidence and find facts regarding the affected_item in an affected items deficiency proceeding verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila united_states tax_court reports to make computational adjustments to the partners’ tax_liabilities to reflect the adjustment of partnership items in the partnership-level proceeding sec_6231 definition of computational adjustment sec_301_6231_a_6_-1t a tem- porary proced admin regs fed reg date the deficiency procedures do not apply to the assess- ment or collection of any computational adjustment unless the computational adjustment involves a deficiency attrib- utable to an affected_item that requires a partner-level deter- mination or to items that have become nonpartnership_items sec a and if the computational adjustment involves a deficiency attributable to an affected_item that requires a partner-level determination the commissioner must issue an affected items notice_of_deficiency to the partner sec a accordingly there are two types of computational adjustments paralleling two types of affected items purely mathematical computational adjustments that do not require partner-level determinations and may be directly assessed see sec a sec_301 a - 1t a temporary proced admin regs supra and adjustments that require partner-level determinations and are therefore subject_to deficiency procedures see sec a sec_301_6231_a_6_-1t a temporary proced admin regs supra after the commissioner issues an affected items notice_of_deficiency generally the partner may file a tax_court petition to contest it see sec_6213 alter- natively the partner can pay the affected_item deficiency file a claim_for_refund and then bring a refund action see u s c sec_1346 the devil of course is in the details and sections as originally enacted raised many difficult interpretive issues that occupied this court and others for years after tefra was enacted for example it became apparent in prac- tice that the litigation procedures as originally enacted did not adequately address how penalties and additions to tax that might require partner-level determinations fit into the partnership litigation regime congress took notice and there is no prepayment forum for contesting the accuracy of such adjustments however if an affected_item deficiency proceeding is pending the tax_court may extend its overpayment jurisdiction to consider computational adjustments that have been assessed and paid see eg 97_tc_548 overpayment jurisdiction applied for example in 87_tc_783 a reviewed opinion this court held that additions to tax and investment_tax_credit carrybacks were affected items verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila petaluma fx partners llc v commissioner began tweaking the tefra provisions to fill gaps in the proce- dures and make them work better two such adjustments occurred when congress as part of the tax_reform_act_of_1986 publaw_99_514 sec d 100_stat_2896 enacted technical corrections to tefra that included adding new section g which extended the period of limitations on assessment with respect to additions to tax affected by adjustments to partnership items and amending section a to permit the commissioner to issue an affected items notice_of_deficiency the most relevant adjustments for purposes of this case however occurred in when con- gress enacted tra c tra before the enactment of tra penalties and additions to tax were classified as affected items and issues regarding such items were litigated in a partner-level deficiency pro- ceeding regardless of whether they related to adjustments to partnership items see eg n c f energy partners v commissio89_tc_741 tra amended sec_6221 to provide that a penalty or addition_to_tax which relates to an adjustment to a partnership_item must be determined at the partnership level tra also amended sec_6226 to provide that a court with jurisdic- tion over a partnership-level proceeding had jurisdiction over a penalty or addition_to_tax which relates to an adjustment to a partnership_item see sec_6226 among other impor- tant changes was the change to section a a i which was amended to read as follows sec additional administrative provisions a coordination with deficiency proceedings - in general -except as provided in paragraph or sub- chapter b of this chapter shall not apply to the assessment or collec- tion of any computational adjustment deficiency proceedings to apply in certain cases - a subchapter_b shall apply to any deficiency attributable to- that must be dismissed from a deficiency proceeding to await the outcome of pending partner- ship proceedings subch b sec_6211 through contains the provisions authorizing the commissioner to issue notices of deficiency and provides the tax_court with jurisdiction to redetermine those deficiencies verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila united_states tax_court reports i affected items which require partner level determinations other than penalties additions to tax and additional_amounts that relate to adjustments to partnership items finally tra provided that a partner may file a claim_for_refund on the ground that the secretary erroneously imposed any penalty addition_to_tax or additional_amount which relates to an adjustment to a partnership_item sec c c as described under the tefra provisions as amended by tra penalties and additions to tax are treated dif- ferently from other affected items the net effect of the tra changes is that deficiency procedures no longer apply to penalties and additions to tax related to adjustments to part- nership items even if they require factual determinations at the partner level sec a a i domulewicz v commissioner t c pincite 129_tc_8 although the court has jurisdiction in a part- nership-level proceeding to consider whether the penalty attributable to an adjustment to a partnership_item applies it has no jurisdiction to decide the amount of the penalty or consider partner-level defenses cf domulewicz v commis- sioner supra pincite d the interaction of sec_6662 and tefra in petaluma as in most typical son-of-boss cases respondent alleged alternative positions with respect to the sec_6662 penalty in the fpaa respondent’s primary posi- tion was that the 40-percent accuracy-related_penalty applied because of a gross_valuation_misstatement of something generally the valuation_misstatement_penalty applies if there is a misstatement of value or basis_of_property on a return see sec_6662 in the petaluma fpaa respondent adjusted the following items to zero capital contributions distributions of property other than money outside partnership basis and the partners’ capital accounts all of these items involve a state- ment of property value or basis and all of the items except outside partnership basis are part- nership items in pertinent part the fpaa stated as follows the formation of petaluma fx partners llc the acquisition of any interest in the purported partnership by the purported partner the purchase of offsetting options the transfer of offset- ting options to a partnership in return for a partnership_interest the purchase of assets by the partnership and the distribution of those assets to the purported partners in complete liquida- tion of the partnership interests and the subsequent sale of those assets to generate a loss had no business_purpose other than tax_avoidance lacked economic_substance and in fact and sub- stance constitutes sic an economic sham for federal_income_tax purposes accordingly the partnership and the transaction described above shall be disregarded in full and any purported losses resulting from these transactions are not allowable as deductions for federal_income_tax purposes verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila petaluma fx partners llc v commissioner and his alternative or additional position was that the percent accuracy-related_penalty attributable to negligence or substantial_understatement_of_income_tax applied generally sec_6662 authorizes the imposition in appropriate cases of an accuracy-related_penalty that poten- tially comprises several components the penalty applies to any portion of an underpayment_of_tax required to be shown on a return sec_6662 if the underpayment or a portion thereof is attributable to one or more of the following negligence or disregard of rules and regulations any substantial_understatement_of_income_tax any substan- tial valuation misstatement any substantial overstate- ment of pension liabilities and any substantial_estate_or_gift_tax_valuation_understatement sec_6662 it is possible that a portion of an underpayment is attributable to one component eg negligence while another portion of the underpayment is attributable to a different component eg gross or substantial_valuation_misstatement the sec_6662 penalty is an ad valorem penalty and its amount ultimately depends on the amount of tax underpayment the seemingly simple concept of penalty calculations how- ever does not fit well in the context of tefra because part- nerships are accounting mechanisms and are not subject_to federal_income_tax see sec_701 the sec_6662 penalty on the other hand applies to a portion of an underpayment emphasis added the term underpayment is a defined term and presupposes tax_shown_on_the_return or tax pre- viously assessed or collected see sec_6664 for this rea- son the amount of the penalty cannot be calculated without reference to the taxpayer’s return and the relevant return for purposes of the penalty calculation is the partner’s return the alternative components of the sec_6662 penalty cannot be stacked and the maximum accuracy-related_penalty imposed on a portion of an underpayment may not exceed percent of such portion or percent of the portion attributable to a gross_valuation_misstatement even if such portion is attributable to more than one type of misconduct described in sec_6662 see sec_1_6662-2 income_tax regs sec_6664 provides sec_6664 underpayment -for purposes of this part the term underpayment means the amount by which any_tax imposed by this title exceeds the excess of- the sum of- a the amount shown as the tax by the taxpayer on his return plus b amounts not so shown previously assessed or collected without assessment over the amount of rebates made verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila united_states tax_court reports as follows from the foregoing the sec_6662 partner- ship-level penalty cannot be calculated and assessed until a computational adjustment is made to a partner’s tax_liability and the underpayment_of_tax on the partner’s return is calculated because of the tefra partnership litigation structure such calculation of the underpayment takes place after the partnership-level proceeding and or partner-level affected items deficiency proceedings are completed creates the sequence of the penalty applicability determination at the partnership level and the subsequent calculation of the underpayment and penalty amounts further incongruities when a particular component of the penalty has a statutory floor for example the substantial or gross valu- ation misstatement component of the penalty applies only if the portion of the underpayment for the year that is attrib- utable to substantial or gross_valuation_misstatements exceeds dollar_figure dollar_figure in the case of a corporation other than an s_corporation see sec_6662 sec_1_6662-5 income_tax regs in the case of a return of a partnership or another pass-through entity the determination of whether there is a substantial or gross_valuation_misstatement is made at the entity level see sec_1_6662-5 income_tax regs however the dollar limitation dollar_figure or dollar_figure as might be applicable is applied at the taxpayer level and the underpayment is calculated by reference to the partner return see id accordingly although it is possible that a statutory floor will ultimately not be met the determination that a penalty applies nevertheless must be made at the partnership level see sec_6221 sec_6226 a a i and is necessarily conditioned upon a later verification that the statutory floor is met that verification flows automatically from the recalculation of the partner’s tax_liability and is reflected in the resulting computational adjustment that is made to the partner’s tax_liability at the end of the partner- ship-level proceeding and or the partner-level affected items deficiency proceeding a similar scenario arises with respect to the substantial_understatement component under sec_6662 b and d a computational adjustment is the change in the tax_liability of a partner which properly reflects the treatment of a partnership_item see sec_6231 verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila petaluma fx partners llc v commissioner as a consequence and in contrast to what occurs in defi- ciency cases a peculiarity of tefra cases is that when a court enters a decision in the partnership-level proceeding stating that a sec_6662 penalty applies neither the amount of the penalty nor its allocation among partners is known until after the underpayment is calculated at the partner level in fact even if the court determines that the penalty applies the amount of the penalty might be zero if the statutory floor is not met in the case of the substantial_understatement and valuation misstatement components or if there is no underpayment by a partnership’s partner see eg sec_1_6662-5 income_tax regs nevertheless under tra the penalty that relates to an adjustment to a partnership_item must be determined at the partnership level see sec_6221 iii negligence in this case the majority holds that we have no jurisdiction over any component of the penalty in this case i believe we have jurisdiction to determine that the sec_6662 penalty attrib- utable to negligence applies that penalty rests on the determination that the petaluma partnership was a sham and is not recognized for federal tax purposes and that all of the transactions in which it engaged which were inter- related and preordained were the result of negligence at the entity level no other factual determinations need be made at the mischaracterization of petaluma as a partnership for federal_income_tax purposes and its claim that it received contribu- tions of property from its partners and made distributions of determine partner level that the to the legislative_history of tra indicates that congress amended sec_6221 sec_6226 and a a i to lessen administrative burdens on the commissioner and the courts and to require that culpability for a penalty or addition_to_tax be litigated at the level on which the relevant conduct occurs many penalties are based upon the conduct of the taxpayer with respect to partnerships the relevant conduct often occurs at the partnership level in addition applying penalties at the partner level through the deficiency procedures following the conclusion of the unified pro- ceeding at the partnership level increases the administrative burden on the irs and can signifi- cantly increase the tax court’s inventory h rept pincite 1997_4_cb_319 the substantial_understatement component of the penalty under sec_6662 b and d would also apply if the statutory floor is met petitioner does not contend that the partnership had substantial_authority or adequately disclosed the transaction see sec_6662 sec_1_6662-4 income_tax regs providing that disclosure in the case of items attributable to a pass-through entity is made with respect to the entity return verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila united_states tax_court reports property to its partners were negligent accordingly what- ever underpayment results from the nonexistence of the part- nership and the adjustment to petaluma’s partnership status which is a partnership_item is attributable to neg- ligence at the partnership level as stated above a penalty must be determined in a part- nership-level proceeding if it relates to an adjustment of a partnership_item see sec_6221 sec_6226 the deter- minations that the petaluma partnership was a sham lacked economic_substance and should be disregarded for tax pur- poses are determinations of partnership items and we have jurisdiction under sec_6226 to decide them in a part- nership-level proceeding petaluma ii f 3d pincite the determination that the partnership should be disregarded or that it or the transactions in which it engaged had no eco- nomic substance is an adjustment to a partnership_item and that is confirmed by a review of the fpaa consistent with respondent’s determination that petaluma was a sham for federal tax purposes the fpaa adjusted all partnership items including contributions made by the partners and dis- tributions made to the partners claimed on the partnership return to zero the critical interpretive issue under sec_6221 sec_6226 and a a i is whether the sec_6662 penalty relates to an adjustment of a partnership_item the majority does not interpret the phrase relates to but in effect applies it overly narrowly generally words in revenue legislation should be interpreted according to their ordinary everyday meaning 103_tc_345 citing 506_us_168 relate means inter alia to show or establish logical or causal connection merriam webster’s collegiate dictionary 10th ed related means inter alia being connected associated the american heritage dictionary of the english language 4th ed there is a logical and causal relationship between the determination of sham a partnership_item and the computational adjustments such determination produces at the partner level because the negligence component of the accuracy-related_penalty relates to an adjustment to a part- nership item shamming of the partnership we have juris- diction under sec_6226 to decide whether the accuracy- verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila petaluma fx partners llc v commissioner related penalty attributable to negligence applies at the part- nership level and i would so hold directly nor jurisdiction neither the majority states the effect of the mandate concerning the sec_6662 penalty is that if the penalty does not relate directly to a numerical adjustment to a partnership_item it is beyond our jurisdiction majority op p the majority thus requires that a penalty directly relate to an adjust- ment and a numerical adjustment to a partnership_item be the only type of partnership_item adjustment invoking our penalty numerical appears in sec_6226 which gives us jurisdiction to determine the applicability of any penalty addition_to_tax or additional_amount which relates to an adjustment to a partnership_item sec_6226 does not require that the penalty directly relate to an adjustment nor does it distin- guish between numerical and nonnumerical adjustments to a partnership_item in addition the petaluma fpaa contains both numerical adjustments which are set forth in a schedule of adjustments and the narrative explanation of items the determination that the partnership was a sham is contained in the explanation of items and is reflected at least in part by the numerical adjustments to specific part- nership items like partners’ capital contributions and partner distributions which are reduced to zero the majority also states in this case none of the fpaa adjustments are items that flow directly to the partner-level deficiency computation as computational adjustments any deficiencies must therefore be determined against the partners as affected items and must be resolved in separate partner-level deficiency procedures the sec_6662 penalties are all related to these adjust- ments which have not yet been made by respondent majority op p petitioner does not contest or disagree with the finding that the partnership was a sham in fact petitioner has conceded the applicability of the 20-percent accuracy-related_penalty for either negligence or substantial_understatement_of_income_tax in the event that the higher percent accuracy-related_penalty for gross_valuation_misstatement does not apply petitioner is contesting only our jurisdiction to determine the sec_6662 penalty for negligence the parties stipulated if the court determines that it has jurisdiction in this case petitioner stipulates that he does not intend to call any witnesses or offer any evidence in this proceeding or otherwise contest the determinations made in the fpaa other than the determination that the valuation_misstatement_penalty imposed by sec_6662 b e and h applies to any under- payment resulting from the adjustments to partnership items although petitioner argues on remand that no component of the accuracy-related_penalty ap- plies the argument seems to be an opportunistic grab for penalty relief on the basis of petaluma ii verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila united_states tax_court reports i interpret this statement to mean that our jurisdiction over the sec_6662 penalty at the partnership level depends on whether the adjustment of a partnership_item results in a computational adjustment that is directly assessed i disagree with that statement because our jurisdictional grant under sec_6226 is not so limited sec_6226 unequivocally provides that we have jurisdiction to decide whether a penalty applies if it relates to an adjustment of a partnership_item in a son-of-boss case like petaluma a tax- payer engages in a set of preordained and interrelated trans- actions to achieve an artificial and inflated tax loss the use of a transient partnership is essential because the partner- ship enables the taxpayer-partner to ultimately claim the disputed loss in the petaluma version of son-of-boss the partners contributed pairs of offsetting options to the part- nership see petaluma ii f 3d pincite when the part- ners withdrew later petaluma liquidated their interests in the partnership by dis- tributing cash and shares of scient stock id the partners then sold the distributed scient stock and claimed an inflated basis in the stock to calculate the loss id the inflated basis in the stock was purportedly possible only because of the partnership vehicle because of the inter- relationship of the transactions and the interplay of the basis rules of subchapter_k the ultimate disallowance of the part- ner’s loss is related to the adjustments to partnership items resulting from the partnership-level proceeding it follows that we have jurisdiction to decide whether the sec_6662 penalty attributable to negligence applies sec_6226 from the partnership months the accuracy-related_penalty asserted in the petaluma fpaa other than the substantial valuation component of the penalty over which the court_of_appeals in petaluma ii held we had no jurisdiction relates to the shamming of the part- nership and to the resulting adjustments to partnership items such as contributions and distributions the conduct that is being sanctioned occurred at the partnership level the petaluma partners could not have achieved the pur- ported loss without the transient existence of the partner- ship the sec_6662 penalty with respect to the partner- ship misconduct must be determined at the partnership level sec_6221 sec_6226 see also domulewicz v commissioner t c pincite verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila petaluma fx partners llc v commissioner the majority relegates the issue of negligence at the part- nership level to an affected items deficiency proceeding that action is foreclosed by section a a i as amended by tra as discussed above under section a a i penalties additions to tax and additional_amounts that relate to adjustments to partnership items no longer are sub- ject to deficiency procedures although congress recognized that a penalty related to an adjustment to a partnership_item might require partner-level determinations congress never- theless explicitly excepted the determination of such pen- alties from the deficiency provisions by amending section a a i temporary regulations under sec_6231 take a similar approach see sec_301_6231_a_6_-1t a temporary proced admin regs supra any penalty addition_to_tax or additional_amount that relates to an adjustment to a partnership_item may be directly assessed following a partnership proceeding based on determinations in that proceeding regardless of whether partner level deter- minations are required for these reasons i would hold that we have jurisdiction to decide that the accuracy-related_penalty attributable to negligence applies at the partnership level cohen gale and paris jj agree with this dissent f in my opinion a finding of negligence at the partnership level in a son-of-boss case such as petaluma does not preclude a finding of partner-level negligence that is because of the unique nature of many son-of-boss transactions which require partnership level and partner- level actions to generate the loss notably respondent took the positions in the fpaa that ac- curacy penalties under sec_6662 are included as a partnership level determination and i r c penalty is applicable at the individual partner level and may be raised in separate proceedings at the partner level following the present partnership proceeding i interpret these seemingly contradictory statements to mean that a sec_6662 penalty is asserted and may apply to both partnership-level conduct such as claiming that a valid partnership existed and to part- ner-level conduct such as claiming an inflated outside_basis for the property distributed by the partnership and sold by the partner verdate 0ct date jkt po frm fmt sfmt v files petaluma sheila


internal_revenue_service department of the treasury number release date index no p o box ben franklin station washington dc person to contact telephone number refer reply to cc dom p si plr-105119-99 re legend date grandparent grandparent grandparent 1’s will grandparent 2’s will daughter daughter’s will spouse beneficiary trust a trustee date date date corporation this is in response to your letter dated date in which you requested a ruling regarding the application of the generation-skipping_transfer gst tax provisions of chapter of the internal_revenue_code specifically you requested a ruling that the exempt status of trust a for gst tax purposes would not be affected by the following i the trustee’s consent to corporation’s s election on behalf of trust a ii the trustee’s execution of an electing_small_business_trust election on behalf of trust a and iii the trustee’s execution of the shareholder agreement on behalf of trust a according to your submission grandparent died testate on date and grandparent died testate on date pursuant to the terms of their wills grandparent and grandparent each created four separate residuary trusts of equal value for the benefit of their four children including daughter article section c of grandparent 1's will and article sec_4 c of grandparent 2's will provide the terms of the four trusts generally each will provides that upon the death of a child the trust estate of such child as then constituted shall be held in trust for the benefit of or distributed to or in trust for the benefit of any one or more of plr-105119-99 such child’s descendants in such amount and in such manner and upon such terms and conditions as such child shall appoint by his or her last will specifically referring to the power_of_appointment conferred upon him or her article section d of grandparent 1's will provides that notwithstanding any other provisions of the will the trusts created pursuant to the terms of the will shall terminate no later than twenty-one years after the death of the last survivor of grandparent and all beneficiaries under the will living at the date of grandparent 1's death article sec_4 f of grandparent 2's will states that notwithstanding any other provisions of the will no property shall be retained in a_trust created pursuant to the terms of the will for more than twenty-one years after the death of the last to die of grandparent 2's descendants living at grandparent 2's date of death daughter died testate on date in her will daughter exercised the testamentary powers of appointment granted to her under article section c of grandparent 1's will and article sec_4 c of grandparent 2's will by directing trustee to divide the property into four trusts of equal value including trust a for the benefit of beneficiary and his descendants pursuant to article sec_3_2 of daughter’s will which provides the terms of trust a the trustee is to pay to a beneficiary for whom a_trust is named and his or her descendants or any one or more of them such part or all of the income and principal of the trust even though exhausting the trust at such time or times and in such equal or unequal proportions among them as the trustee believes desirable for the best interests and welfare of such beneficiary and his or her descendants in that order and as a group considering the desirability of supplementing their respective incomes or assets and all other circumstances and factors the trustee believes pertinent any undistributed_income of a_trust shall be accumulated and from time to time added to principal article sec_3_2 of daughter’s will provides that if a beneficiary living at or born after daughter’s death dies before the time fixed by daughter’s will for the complete distribution of the trust named for him or her then on the death of such beneficiary or on the division date if he or she is deceased the principal of the trust shall be distributed to or for the benefit of such of daughter’s descendants then living or thereafter born in such proportions and subject_to such trusts powers and conditions as such beneficiary may provide and appoint by will plr-105119-99 article sec_3_2 provides that on the death of a beneficiary for whom a_trust is named or on the division date if such beneficiary is then deceased any principal of the trust not effectively disposed of shall be allocated per stirpes among the then living descendants of the beneficiary if any if there are no such descendants the trust estate or the part not effectively appointed shall be distributed per stirpes among the then living descendants of the nearest lineal ancestor of the beneficiary who also was a descendant of daughter and of whom one or more descendants then are living or if none per stirpes among daughter’s then living descendants each share allocated to a beneficiary for whom a_trust then held is named shall be added to that trust and each share allocated to any other beneficiary shall be retained in trust as a separate trust named for him or her article sec_3_2 provides that notwithstanding any other provisions of daughter’s will on the day next preceding the end of twenty-one years after the death of the last to die of spouse and the descendants of grandparent living at grandparent 1's death on date the trustee is directed to distribute any property then held in a_trust to the beneficiary for whom the trust is named the primary asset of trust a is stock in corporation a c_corporation the corporation’s board_of directors proposes to elect to treat corporation as a small_business_corporation an s_corporation trustee proposes to consent to the s election in order to convert corporation to an s_corporation each of its shareholders must be eligible to hold s_corporation stock as of the first day of the year for which the election is to take effect trustee proposes to make an election under sec_1361 to treat trust a as an electing_small_business_trust so that it will qualify as an eligible s_corporation shareholder in an effort to ensure the continuing qualification of corporation as an s_corporation trustee intends to enter into a shareholder agreement with corporation and corporation’s other shareholders to protect the s election under sec_3 of the proposed shareholder agreement no shareholder may transfer and no person may acquire the legal or beneficial_ownership of any share if such transfer or acquisition would cause the s status of the corporation to terminate specifically no transfer may be made to any person that is not eligible to be a shareholder of an s_corporation under the applicable provisions of the code as in effect at the time of the purported transfer in addition no shareholder may affirmatively transfer shares to a person if the transfer would cause the corporation to exceed the maximum number of persons who are allowable s_corporation shareholders plr-105119-99 sec_3 of the proposed shareholder agreement provides that no shareholder shall make any transfer of shares to any trust having multiple beneficiaries or amend any trust that owns shares to increase the number of beneficiaries unless all such beneficiaries are persons eligible to be transferees pursuant to sec_3 and immediately after such transfer or amendment the number of shareholders the corporation is deemed to have for purposes of sec_1361 would not exceed the maximum number of persons who are allowable s_corporation shareholders pursuant to that section notwithstanding any other provision of the shareholder agreement the shareholders and the corporation acknowledge and agree in sec_3 that none of the following shall be prohibited by the terms of the shareholder agreement i the addition of a_trust beneficiary due to the birth of an additional descendant of grandparent ii the exercise of a power_of_appointment granted to a beneficiary pursuant to the terms of any irrevocable_trust that is in existence on the date of the agreement and that owns shares iii the transfer of shares to any person in whose favor a power_of_appointment described in ii above is exercised or iv the distribution of shares to a a beneficiary of any irrevocable_trust that is in existence on the date of the agreement and that owns shares pursuant to the terms thereof or b to the beneficiary of any trust created pursuant to the exercise of a power_of_appointment described in ii above even if such addition exercise or distribution shall cause the termination of the corporation’s s election sec_3 provides that prior to any transfer or other_disposition of shares if the corporation in its discretion so requires an opinion of counsel to the corporation must first be received by the corporation the cost of which shall be borne by the shareholder whose shares are to be transferred or disposed of that the transferee is i eligible to be a shareholder of an s_corporation in accordance with the applicable_requirements of the code or ii that the transfer otherwise is allowable pursuant to the provisions of the shareholder agreement in addition to the other requirements of sec_3 of the shareholder agreement sec_3 provides that no transfer of shares including without limitation transfers pursuant to sec_3 shall be permitted and no purported transfer shall be effective until a permitted transferee has executed a supplemental signature page to the shareholder agreement all parties agree that upon execution and acceptance of a supplemental signature page the shareholder agreement shall be amended and the transferee shall have the rights and obligations of a shareholder under the agreement plr-105119-99 sec_3 of the shareholder agreement provides that shareholders possessing of the total voting power of all outstanding shares may at any time and from time to time agree in writing to authorize or ratify any transfer of shares which would otherwise not be permitted by the shareholder agreement in which event the transfer shall be deemed for all purposes to comply with the shareholder agreement notwithstanding any other provision of the agreement under sec_3 if a transfer of shares is required to be made pursuant to sec_3 iii or iv to a transferee who is not already a shareholder and who has not previously executed or currently refuses to execute a supplemental signature page to the shareholder agreement a non- consenting transferee certain procedures will apply the shareholders may allow the transfer of shares to the non- consenting transferee pursuant to the procedure set forth in sec_3 otherwise the shares that otherwise would be transferred to the non-consenting transferee shall instead be redeemed by the corporation for a price equal to the fair_market_value of the shares as of the valuation_date pursuant to sec_5 of the proposed shareholder agreement any purported transfer in violation of the shareholder agreement shall not affect the beneficial or legal ownership of shares section of the agreement states that subject_to any limitations on dividends or other distributions imposed by statute the corporation shall make pro_rata dividend distributions of money based on ownership of shares to pay the federal state and local income_tax on the income and gain of the corporation net of any_tax benefits produced for the shareholders by the corporation’s losses deductions and credits for the current_year and for each prior year during which the corporation’s s election was in effect that passes through to the shareholders under the applicable provisions of the code in respect of each taxable_year or portion thereof of the corporation for which its s election is in effect section of the proposed shareholder agreement provides that the corporation shall a not issue more than one class of shares b use its best efforts to avoid a termination of its s election and c in the event of a termination of the s election use its best efforts to distribute to each shareholder such shareholder’s net share of the corporation’s undistributed_taxable_income for all taxable years for which the s election was in effect to the extent permitted by law and consistent with the obligations of the corporation to creditors agreements to which the corporation is a party and other business considerations within the period when such a distribution will be considered a non-dividend distribution under sec_1371 plr-105119-99 section of the proposed shareholder agreement states that if the corporation’s status as an s_corporation is terminated inadvertently and the corporation wishes to obtain a ruling under sec_1362 each shareholder agrees to make any adjustments required pursuant to sec_1362 and approved by the corporation’s board_of directors a shareholder’s obligation to make such adjustments shall continue after the shareholder has ceased to own shares in the corporation and after the shareholder agreement has terminated except as directed by the shareholder agreement the existing trustee will continue to serve in the same manner as it previously served in addition trust a will continue to be administered in accordance with the terms and conditions set forth in daughter’s will sec_2601 imposes a tax on every generation-skipping_transfer sec_26_2601-1 of the generation-skipping_transfer_tax regulations provides that the gst tax applies to any generation-skipping_transfer made after date sec_26_2601-1 provides an exception to this rule for any distributions from a_trust that was irrevocable on date however this exception does not apply to a pro_rata portion of any generation-skipping_transfer under an irrevocable_trust where additions were made to the trust after date in addition a modification to a_trust that results in a change in the quality value or timing of any beneficial_interest provided for under the trust instrument will cause the trust to lose its exempt status sec_26_2601-1 provides that except as provided under sec_26_2601-1 where any portion of a_trust remains in the trust after the post-date release exercise or lapse of a power_of_appointment over that portion of the trust and the release exercise or lapse is treated to any extent as a taxable transfer under chapter or chapter the value of the entire portion of the trust subject_to the power that was released exercised or lapsed is treated as if that portion had been withdrawn and immediately retransferred to the trust at the time of the release exercise or lapse sec_26_2601-1 provides a special rule for certain powers of appointment this section provides that the release exercise or lapse of a power_of_appointment other than a general_power_of_appointment as defined in sec_2041 will not be treated as an addition to a_trust if- such power_of_appointment was created in an irrevocable_trust that is not subject_to chapter under sec_26_2601-1 and in the plr-105119-99 case of an exercise such power_of_appointment is not exercised in a manner that may postpone or suspend the vesting absolute ownership or power of alienation of an interest in property for a period measured from the date of creation of the trust extending beyond any life in being at the date of creation of the trust plus a period of years sec_2041 provides that the term general_power_of_appointment means a power that is exercisable in favor of the individual possessing the power his estate his creditors or the creditors of his estate in this case trust a was created pursuant to the exercise after date of daughter’s limited_power_of_appointment because the exercise of daughter’s limited power satisfies the requirements of sec_26_2601-1 property passing to the trust pursuant to daughter’s exercise is not considered a post-date addition to the trust further it is represented that there have been no additions constructive or otherwise to trust a after that date based on the representations made and the facts submitted we conclude that there is no change in the quality value or timing of any beneficial_interest in trust a resulting from the following i the trustee’s consent to corporation’s proposed s election ii the trustee’s election to treat trust a as an electing_small_business_trust and iii the trustee’s execution of the proposed shareholder agreement therefore items i - iii above will not cause trust a to lose its exempt status with respect to the gst tax provided that there are no additions constructive or otherwise to trust a after date distributions from trust a to skip persons will not be subject_to the gst tax except as specifically ruled herein we express no opinion as to the consequences of this transaction under the cited provisions of the code or under any other provisions of the code specifically we express no opinion on whether trust a will qualify as an electing_small_business_trust within the meaning of sec_1361 this ruling is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent sincerely assistant chief_counsel passthroughs and special industries by george masnik chief branch enclosure copy for sec_6110 purposes


department of the treasury internal_revenue_service washington d c contact person identification_number telephone number employer_identification_number tax exempt ano govermment entities number release date date uil dollar_figure date former spous corporation foundation dear we have considered your ruling_request dated date concerning the excise_tax consequences under sec_4941 of the internal revenue cade code related to a proposed transfer of assets in the manner and for the purposes described below foundation has been recognized as an organization exempt under sec_501 of the code and is classified as a private_foundation within the meaning of sec_509 b's former spouse was the founder of both foundation and corporation b also made substantial contributions to foundation b had the right so long as she lived either to be a director of foundation or to appoint another to serve in her place as a director subject however to her tight to rescind that appointment and either ta resume har service as a director or to appoint during her lifetime b appointed her daughter d to serve in her another to serve in her place place as a director of foundation b's daughter d and her son f are personal_representatives of the estate of b corporation is a holding_company which conducts business through a number of wholly-owned subsidiaries e has two classes of stock voting and nonvoting f owns all shares of voting common_stock and is also a director of foundation corporation has made substantial contributions to the foundation upon b's death b devised the residue of her estate to foundation this residue included the ownership of certain timber properties the land was acquired as investment_property and was originally held as an undivided percent tenancy-in-common interest with former spouse the land holdings of both b and former spouse were subject_to substantially identical option agreements singularly referred to herein as option agreement which granted corporation the right to acquire these holdings at any time up until the estate of the optionor terminated at the then-current fair_market_value as determined by an independent_appraiser after former spouse died leaving the residue of former spouse's estate to foundation corporation exercised its rights under the option agreement with former spouse and acquired the land holdings from former spouse's estate these holdings were then stil held as a tenancy-in-common interest with b following acquisition of former spouse's property corporation entered into a series of exchange transactions with b so that corporation and b would each own the entire_interest in approximately half the property instead of undivided interests in the whole we ruled in separate rulings that the transaction between corporation and the estate of former spouse was not an act of self-dealing pursuant to sec_53 a - of the foundation and similar excise_tax regulations ‘regulations’ corporation exercised the option granted to it by the option agreement with b through a third party intermediary an assignee of the corporation pursuant to the option agreement the price paid_by the assignee of the corporation to the estate of b was above the fair_market_value af the land determined as of the date of the exercise of the option this fair_market_value was determined by an agreed upon independent_appraiser during this process the estate of b was guided by a committee of members of the board_of the foundation each of whom is independent of corporation in exchange for the land being transferred to an assignee of the corporation pursuant to the option agreement the estate of b received all cash in an amount represented to be above fait market_value you state that the appropriate state attorney_general acknowledged that it had received a copy of the petition filed by you seeking approval of the sale and that the attorney_general did not file any objections to that petition probate_court with jurisdiction over b's estate you also represent that the transaction was approved by the requested rulings the personal_representatives of the estate of b for themselves and the estate corporation and the foundation for itself and its managers request a ruling that pursuant to sec_53 d - b of the regulations the estate's sale of the land holdings of b to an assignee of the corporation pursuant to the terms and provisions of the option agreement for the price determined as specified in the option agreement followed by the assignee's transfer of the property to corporation will not be an act of self-dealing under sec_4941 of the cade by any of the parties the estate of b the personal_representatives of the estate corporation the foundation or the foundation's managers law sec_501 c of the code exempts from federal_income_tax organization organized and operated exclusively for charitable or educational_purposes sec_507 of the code defines a substantial_contributor as any person who contributed or bequeathed an aggregated amount of more than dollar_figure to a private_foundation if such amount is more than percent of the total contributions and bequests received by the foundation before the close of the taxable_year of the foundation in which the contribution or bequest is received by the foundation from such person sec_4941 of the code imposes an excise_tax on each act of self-dealing between a disqualified_person and a private_foundation sec_4941 of the code defines self-dealing as including a sale_or_exchange of property or the extension of credit between a foundation and a disqualified_person whether done directly or indirectly sec_4946 of the code defines the term disqualified persons with respect to a private_foundation as including a substantial_contributor to the foundation a foundation_manager and an owner of more than percent of the total combined voting power of a corporation which is a substantial_contributor to the foundation it also includes a member_of_the_family of any individual described above in addition it includes a_trust or estate in which persons described in above hold more than percent of the beneficial_interest sec_4946 of the cade defines the term foundation_manager as including an officer director or trustee of a foundation or an individual having powers or responsibilities similar to those of officers directors or trustees of the foundation sec_4946 of the code states that the term a member_of_the_family of a disqualified_person includes the spouse children of and grandchildren of a disqualified_person sec_83 d -1 a of the regulations provides in general that for the purposes of sec_4941 the term self-dealing means any direct or indirect transaction described in sec_53 a -2 of the regulations sec_53 d -1 b of the regulations provides that certain transactions described in sec_53 d -2 as indirect self-dealing are excapted from the definition of indirect self- dealing sec_53 d -1 b of the regulations provides that the term indirect seff-dealing shall not include a transaction with respect to a private foundation's interest or expectancy in property whether or not encumbered held by an estate or revocable_trust including a_trust which has become imevocable on a grantor's death regardless of when itte to the property vests under local law if- the administrator or executor of an estate or trustee of a revocable_trust either - a possess a power of sale with respect to the property b has the power to reallocate the property to another beneficiary or c is required to sell the property under the terms of any option subject_to which the property was acquired by the estate or revocable_trust ii such transaction is approved by the probate_court having jurisdiction over the estate or by another court having jurisdiction over the estate_or_trust or over the private_foundation il such transaction occurs before the estate is considered terminated for federal_income_tax purposes pursuant to paragraph a of sec_1_641_b_-3 of this chapter or in the case of a revocable_trust before it is considered subject ta sec_4947 iv the estate_or_trust receives an amount which equals or exceeds the fair_market_value of the foundation's interest or expectancy in such property at the time of the transaction taking into account tha terms of any option subject_to which the property was acquired by the estate_or_trust and v with respect to transaction occurring after date the transaction either - gave up results in the foundation receiving an interest or expectancy at least as liquid as the one it b results in the foundation receiving an asset related to the active carrying out of its exempt purposes or c is required under the terms of any option which is binding on the estate_or_trust sec_53 d -1 b of the regulations example describes a situation where a substantial_contributor to a private_foundation bequeaths one-half of his estate to his spouse and one-half to the private_foundation the estate includes a one-third interest in a partnership the remaining two-thirds of the partnership are owned by a disqualified_person to the private_foundation the one-third interest was subject_to an option agreement when it was acquired by the estate the sale of the one-third interest in the partnership to the disqualified_person did not constituta an act of self-dealing because the transaction satisfied the requirements set forth in sec_53_4941_d_-1 sec_53 d -2 a of the regulations provides that in general the sale_or_exchange of property between a private_foundation and a disqualified_person shall constitute an act of self- dealing analysis generally transactions between a disqualified_person and a foundation are subject_to the self- dealing rules set forth in sec_4941 of the code sec_4941 defines self-dealing to include any direct or indirect sale_or_exchange or leasing of property between a private_foundation and a disqualified_person under sec_63 d -1 of the regulations the sale by an estate of property in which a private_foundation has an expectancy under a will can be an act of indirect self-dealing if the transaction described above were determined to be an act of self-dealing it would subject the self-dealing persons to an excise_tax on each act of self- dealing between a disqualified_person and a private_foundation pursuant to sec_4941 however in order to apply sec_4941 we must first determine if there are disqualified persone in the transaction with the private_foundation here corporation is a disqualified_person with respect to the foundation under sec_4946 e of the code because it was a substantial_contributor to the foundation sec_507 of the code provides that a substantial_contributor is any person who contributed an aggregate amount of more than dollar_figure to a private_foundation if such amount is more than percent of total contributions corporation has contributed substantially more than dollar_figure which you state was more than of tofal contributions additionally d and f are disqualified persons with respect to the foundation pursuant to sec_4946 of the code that section states that the term a member_of_the_family of a disqualified_person includes the spouse children of and grandchildren of a disqualified_person d and f are children of b a disqualified_person as well as being the executors of b's estate and directors of foundation f is aiso the owner of all the voting_stock of corporation thus d and f are disqualified persons with respect to the foundation however transactions during the administration of an estate regarding the foundation's interest or expectancy in property held by such estate are nat seff-dealing if all ive conditions set forth in sec_53 d -1 b of the regulations are met such exception to the self-dealing rules is commonly referred to as the estate administration exception the first requirement of the estate administration exception is sec_53 d -1 b i of the regulations which provides in part that the administrator of an estate is required to sell the property under the terms of any option subject_to which the property was acquired by the estate here b during her iifetime entered into an option agreement with corporation to sell the property to corporation in exchange for which b or her estate would receive fair_market_value of the assets transferred as determined by an independent_appraiser since the personal tepresentatives of b's estate are required to sell the properly under the terms of the option agreement subject_to which the property was acquired by the estate the transaction meets this first requirement the second requirement as set forth in sec_53 d -7 b i of the regulations provides that the transaction must be approved by the probate_court having jurisdiction over the estate here you have represented that the sale transaction has been approved by the probate_court having jurisdiction aver the estate thus the second condition has been met the third requirement pursuant to sec_53 d -1 b i of the regulations provides that such transaction occurs before the estate is considered terminated for federal_income_tax purposes here according to the facts you have represented that the transaction occurred prior to the estate being terminated for federal_income_tax purposes agreement specifically provided that the corporation could exercise its option at any time up until the estate of the optionor terminated fourth sec_53 d -1 b iv of the regulations provides that the estate receives an amount which equals or exceeds the fair_market_value of the foundation's interest or expectancy in such property at the time of the transaction taking into account the terms of any option subject_to which the properly was acquirad by the estate here the option agreement specifies that the purchase_price will be the fair_market_value as determined by an independent appraisal thus this third condition has been met additionally the option the estate of b in exchange for selling the property interest pursuant to the option agreement received an amount greater than the appraised amount and received all cash in the transaction thus the requirement of subsection iv of sec_53 d -1 b of the regulations that the estate receives an amount which equals the fair_market_value of the foundation’s interest or expectancy in the property holdings at the time of the transaction was met the last requirement of the estate administration exception is that the transaction results in the foundation receiving an interest or expectancy at least as liquid as the one it gave up here the estate and thereby the foundation gave up real_property in exchange for all cash thus the estate received an interest at least as liquid as the one it gave up since the transaction outlined above meets the requirements for the estate administration ‘exception the transaction will not be subject_to the self-dealing rules set forth in sec_4941 of the code ruling the sale by the estate of b and purchase of the interest by an assignee of corporation pursuant to the terms and provisions of the option agreement will not be an act of seif-dealing under sec_4941 of the code by the estate of in this ruling we have not determined whether ths methodology used to determine fair_market_value of the assets is proper we merely have accepted the given representation that the appraisal reflacts fair_market_value in this ruling we also have not determined whether the mechanism of the deferred_like-kind_exchange pursuant to sec_1031 of the code is proper this ruling will be made available for public inspection under sec_6110 of the code after certain deletions of identifying information are made for details see enclosed notice notice of intention to disclose a copy of this ruling with deletions that we intend to make available for public inspection is attached to notice if you disagree with our proposed deletions you should follow the instructions in notice this ruling is directed only to the organization that requested it sec_61 k of the code provides that it may not be used or cited by others as precedent this ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts this ruling does not address the applicability of any section of the code or regulations to the facts submitted other than with respect to the sections described because it could help resclved questions concerning your federal_income_tax status this ruling should be kept in your permanent racords if you have any questions about this ruling please contact the person whose name and telephone number are shown in the heading of this letter in accordance with the power_of_attorney currently on file with the internal_revenue_service we are sending a copy of this letter to your authorized representative sincerely ellen berick ronald j shoemaker manager exempt_organizations technical group enclosure notice