Court Opinion

ID: 613735
Source: CourtListenerOpinion
Date Created: 2011-09-16 00:24:25+00
Date Added: 2024-06-11T08:07:21.169570
License: Public Domain

United States Court of Appeals
         FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued April 5, 2011                 Decided June 21, 2011
                              Resubmitted September 15, 2011

                        No. 10-1262

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

                             v.

      COMMISSIONER OF INTERNAL REVENUE SERVICE,
                     APPELLANT

          Appeal from the United States Tax Court

    Gilbert S. Rothenberg, Deputy Assistant Attorney General,
U.S. Department of Justice, argued the cause for appellant.
With him on the briefs were Michael J. Haungs and Joan I.
Oppenheimer, Attorneys.

    James F. Martens argued the cause for appellees. With him
on the brief were Michael B. Seay, Amanda Traphagan, and
Renea Hicks.

     Roger J. Jones, Andrew R. Roberson and Kim Marie
Boylan, were on the brief for amicus curiae Bausch & Lomb
Incorporated in support of appellees.
                                2

   Before: SENTELLE, Chief Judge, TATEL, Circuit Judge, and
RANDOLPH, Senior Circuit Judge.

   Opinion for the Court filed by Senior Circuit Judge
RANDOLPH.

     RANDOLPH, Senior Circuit Judge: This appeal presents two
broad issues. The first is whether an understatement of income
can trigger the six-year, extended tax assessment period under
§ 6501(e)(i)(A) of the Internal Revenue Code (26 U.S.C.) when
the understatement results from an overstatement of basis in sold
property. The second is whether the mailing of a notice of final
partnership administrative adjustment by the IRS tolls an
individual partner’s limitation period under I.R.C. § 6501. In a
companion case, we have resolved the first issue in favor of the
IRS. See Intermountain Ins. Serv. of Vail, LLC v. Comm’r, No.
10-1204 (D.C. Cir. June 21, 2011) (as amended Aug. 18, 2011).
We write separately to address the second.

      The issues arise from the following facts. David Morgan
formed an insurance business under the name “Success Life.”
He later merged Success Life into UTA Management, an S
corporation he solely owned. (Under the Code, the income and
losses of an S corporation are passed through to its shareholders
for federal tax purposes.) In 1999, Morgan caused UTA
Management’s assets to be contributed to UTAM, a newly
formed limited partnership. UTA Management owned a ninety-
nine percent partnership interest in UTAM. DDM Management,
a separate S corporation owned by Morgan and members of his
family, held the remaining one percent. Morgan later agreed to
sell the partnership interests of UTA Management and DDM to
an unrelated insurance company.

     Before the sale, Morgan entered into a series of transactions
that had the effect of inflating UTA Management’s “outside
                                  3

basis” in the UTAM partnership. A partner’s outside basis is the
value assigned to the partner’s investment in his partnership
interest. See Am. Boat Co. v. United States, 583 F.3d 471, 474
n.1 (7th Cir. 2009). When a partner sells his partnership
interest, the basis is subtracted from the sale price to calculate
the partner’s capital gain or loss from the sale. See
I.R.C. §§ 61(a)(3), 1001(a). The higher a partner’s basis, the
lower the income resulting from the sale of the partnership for
federal tax purposes.

     To increase UTA Management’s outside basis in the
partnership, Morgan sold short U.S. Treasury notes with a face
value of $38 million, receiving cash proceeds of just under that
amount. In a short-sale transaction, borrowed property is sold,
with the seller incurring an obligation to later buy an equivalent
amount of that property and thus “close” the sale. See generally
Zlotnick v. TIE Commc’ns, 836 F.2d 818, 820 (3d Cir. 1988).
Morgan transferred the proceeds received from the short sale,
along with the obligation to close the sale, to UTA Management,
which then transferred them to UTAM. By doing so, Morgan
raised UTA Management’s outside basis in the partnership by
nearly $38 million—the amount of the sale proceeds—without
accounting for the corresponding obligation to buy.1 UTAM
later closed the sale by buying Treasury notes for slightly more
than $38 million, resulting in an overall loss to UTAM from the
transaction.

     The sale of UTAM closed on October 19, 1999. Morgan
elected to have the stock sale treated as the sale of UTA
Management’s assets for income tax purposes. The tax

    1
       In 2000, the IRS clarified that such transactions—known
popularly as “Son of BOSS” tax shelters—were abusive when used to
generate artificial losses for tax purposes. See I.R.S. Notice 2000–44,
2000–2 C.B. 255.
                               4

consequences of the sale were reflected on UTA Management’s
1999 return, filed on August 15, 2000. Because the short-sale
transactions raised UTA Management’s outside basis in the
partnership to more than $41 million, UTA Management
claimed an overall loss of approximately $13 million. This
number was derived by subtracting UTA Management’s outside
basis from the $28 million received for its interest. Without the
basis increase resulting from the short-sale transactions, UTA
Management would have realized a capital gain of
approximately $25 million. Morgan filed his 1999 individual
return on October 16, 2000. On that return he reported the flow
through loss from the sale.

     On October 13, 2006—more than six years after the filing
of UTAM’s 1999 partnership return but less than six years from
the filing of Morgan’s 1999 individual return—the IRS mailed
a notice of final partnership administrative adjustment to DDM
Management (UTAM’s “tax matters” partner) pertaining to
UTAM’s 1999 tax year. In the notice, the IRS adjusted the
firm’s outside partnership basis to zero. The IRS explained that
the short-sale transactions “lacked economic substance, and, in
fact and substance, constitute[d] an economic sham for federal
income tax purposes.” It determined that UTA Management
should have reduced its outside basis to account for the
offsetting obligations that were transferred to UTAM along with
the short-sale proceeds. And it found that UTAM was itself a
sham, existing solely for tax avoidance purposes.

     DDM Management filed a timely petition for readjustment
of partnership items with the Tax Court. See I.R.C. § 6226(a).
DDM and UTAM argued, among other things, that the IRS’s
adjustments were barred by the general three-year limitation
                                   5

period for tax assessments in I.R.C. § 6501(a).2 The Tax Court
agreed, relying on Colony, Inc. v. Commissioner, 357 U.S. 28
(1958). That case, interpreting a predecessor provision to
§ 6501, held that the extended assessment period that applies
when “the taxpayer omits from gross income an amount
properly includible therein which is in excess of 25 percent of
the amount of gross income stated in the return” is not triggered
by an understatement of income resulting from an overstatement
of basis in sold property.3 Id. at 36-38.

    2
        That section states, in relevant part: “Except as otherwise
provided in this section, the amount of any tax imposed by this title
shall be assessed within 3 years after the return was filed (whether or
not such return was filed on or after the date prescribed) . . ..” I.R.C.
§ 6501(a).
    3
      The extended six-year assessment period is currently located at
I.R.C. § 6501(e)(1)(A). The version of § 6501(e)(1)(A) applicable in
1999, the tax year in question, read:

    (e) Substantial omission of items
        Except as otherwise provided in subsection (c)—
        (1) Income taxes.—In the case of any tax imposed by subtitle
        A—
        (A) General Rule.—If the taxpayer omits from gross income
        an amount properly includible therein which is in excess of 25
        percent of the amount of gross income stated in the return, the
        tax may be assessed, or a proceeding in court for the
        collection of such tax may be begun without assessment, at
        any time within 6 years after the return was filed. For
        purposes of this subparagraph—
             (i) In the case of a trade or business, the term “gross
             income” means the total of the amounts received or
             accrued from the sale of goods or services (if such
             amounts are required to be shown on the return) prior to
             the diminution by the cost of such sales or services; and
             (ii) In determining the amount omitted from gross
                                  6

     For the reasons stated in Intermountain Insurance Service
of Vail, LLC v. Commissioner, No. 10-1204 (D.C. Cir. June 21,
2011) (as amended Aug. 18, 2011), we disagree with the Tax
Court and hold that the six-year limitations period applies with
regard to Morgan’s 1999 return.4 This, however, does not end
the case. UTAM has other defenses the Tax Court did not reach,
defenses that raise issues not presented in Intermountain. For
several reasons, UTAM claims that the mailing of the notice of
final partnership administrative adjustment (usually known
simply as an “FPAA”) to DDM Management did not toll the
running of Morgan’s § 6501 limitations period. In other words,
even though the FPAA came less than six years after Morgan
filed his 1999 return, the limitations period expired during the
proceedings that followed.

     To evaluate UTAM’s claims it is necessary to understand
how the Tax Equity and Fiscal Responsibility Act of 1982, Pub.
L. No. 97-248, 96 Stat. 324 (codified as amended at I.R.C.
§§ 6221-6232), deals with partnerships. An important point is
that partnerships do not pay taxes; only individual partners do.
Even so, partnerships must file annual informational returns.
See Petaluma FX Partners, LLC v. Comm’r, 591 F.3d 649, 650
(D.C. Cir. 2010). When the IRS disagrees with how a

            income, there shall not be taken into account any amount
            which is omitted from gross income stated in the return if
            such amount is disclosed in the return, or in a statement
            attached to the return, in a manner adequate to apprise the
            Secretary of the nature and amount of such item.

I.R.C. § 6501(e)(1)(A) (2000).
    4
     We express no view on the question whether the nature and
amount of Morgan’s income was adequately disclosed within the
meaning of I.R.C. § 6501(e)(1)(A)(ii). This issue remains open to the
Tax Court on remand.
                                   7

partnership return has reported a “partnership item,”5 it mails a
notice of final partnership administrative adjustment to the
partners. See I.R.C. § 6223(a); Petaluma FX Partners, 591 F.3d
at 651. If the partnership’s “tax matters partner” wishes to
contest an adjustment, he may file a petition for readjustment
within ninety days. I.R.C. § 6226(a). The petition initiates a
court proceeding to determine all partnership items addressed in
the FPAA. See id. § 6226(f). Only after this proceeding may
the IRS assess any resulting tax against the individual partners.
Id. § 6225(a).

     There is no separate limitations period for the mailing of the
notice of final partnership administrative adjustment. But the
notice would have no point if the IRS sent it after all of the
individual partners’ assessment periods had expired for taxes
reflected in the adjustment. See Rhone-Poulenc Surfactants &
Specialities, L.P. v. Comm’r, 114 T.C. 533, 534-35 (2000). The
Tax Equity and Fiscal Responsibility Act therefore contains a
special provision for calculating a partner’s assessment period
with respect to tax attributable to partnership items and
“affected” items.6 Normally an individual’s assessment period
is calculated from the date on which he filed his personal return.
See I.R.C. § 6501(a). But § 6229(a) of the Internal Revenue
Code provides that “the period for assessing any tax imposed by
subtitle A with respect to any person which is attributable to any
partnership item (or affected item) for a partnership taxable year

    5
      A partnership item is “any item required to be taken into account
for the partnership’s taxable year under any provision of subtitle A to
the extent regulations prescribed by the Secretary provide that, for
purposes of this subtitle, such item is more appropriately determined
at the partnership level than at the partner level.” I.R.C. § 6231(a)(3).
    6
     An affected item is “any item to the extent such item is affected
by a partnership item.” I.R.C. § 6231(a)(5).
                                8

shall not expire” before the later of the filing of the partnership
return or the last day for filing such a return, plus three years.
Subsection 6229(c)(2) extends this three-year assessment
window to six years after the filing of the partnership return
when there is a substantial omission of income on the
partnership return. Id. § 6229(c). These provisions have the
effect of extending an individual partner’s assessment period
whenever the partnership return is filed after that individual’s
personal return.

     The provision with which we are concerned—
§ 6229(d)—states that “[i]f notice of a final partnership
administrative adjustment with respect to any taxable year is
mailed to the tax matters partner, the running of the period
specified in [I.R.C. § 6229(a)] . . . shall be suspended” for the
pendency of any proceeding initiated under § 6226 and for one
year thereafter. Id. § 6229(d). UTAM argues that the “period
specified” in § 6229(a) refers only to the assessment period
specific to partnership (and affected) items. Under the parties’
stipulations, this period expired before the IRS mailed the notice
of final partnership administrative adjustment. Thus, UTAM
argues, there was nothing for § 6229(d) to suspend.

     Although the Tax Court did not reach the issue, that court’s
en banc opinion in Rhone-Poulenc, 114 T.C. 533, determined
that § 6229(d) suspends the running of an individual partner’s
§ 6501 limitations period when that period is open on the date
the IRS mailed the FPAA. A remand on this particular issue
would therefore serve no useful purpose. The Tax Court has
already stated its position, a position with which we agree for
the reasons that follow.

    The only period “specified” in § 6229(a) is “the period for
assessing any tax imposed by subtitle A with respect to any
person which is attributable to any partnership item (or affected
                                 9

item) for a partnership taxable year . . ..” Since partnerships are
not taxed, we take this language to refer to a partner’s generally
applicable assessment period as provided in § 6501. See
Andantech, L.L.C. v. Comm’r, 331 F.3d 972, 976-77 (D.C. Cir.
2003). In Morgan’s case, that period is, as we have said, six
years. By the time of the FPAA, the period provided by § 6229
had passed, but the six-year period under § 6501 applicable to
Morgan’s individual return was still running.

     Logic does not give starting points. Binding opinions of
this court do. Our decision in Andantech is such a starting point.
We there decided that § 6229(a) does not provide the maximum
period for assessments, even with respect to partnership items.
That, we said, is the function of § 6501, which is why the period
set forth there is a “limitation.” Section 6229(a), on the other
hand, is something else again; rather than a limitation, it is a
minimum period for the IRS to take action. Andantech, 331 F.3d
at 976-77. Put differently, § 6229(a) tells us that the IRS has at
least this much time to proceed—but that tells us nothing about
how much beyond this time the IRS has. Yet if we were to
accept UTAM’s position that the FPAA cannot toll individual
partners’ § 6501 periods after the § 6229(a) minimum period
passes, we would be converting the minimum period in many
cases into a limitation period, in contravention of the premise of
Andantech. We therefore hold that the assessment period
suspended pursuant to § 6229(d) is the partner’s open
assessment period under § 6501.7

    7
       UTAM argues that even if § 6229(d) can be used to toll a
partner’s open § 6501 period, it did not do so here because the FPAA
adjusted only nonpartnership items and was therefore invalid.
UTAM’s argument rests on certain factual stipulations the parties
made in the Tax Court for purposes of litigating the statute of
limitations issue. But there was no stipulation that the FPAA was
“invalid,” as UTAM claims. The FPAA gave notice of the
                                 10

     The judgment of the Tax Court on the statute of limitations
issue is reversed. The case is remanded for further proceedings
consistent with this opinion.

                                                        So ordered.

Commissioner’s determination of adjustments to partnership items.
See, e.g., Clovis I v. Comm’r, 88 T.C. 980, 982 (1987). These
included sham transactions and their attendant incomes, gains, losses,
and deductions. The nature of the adjustments in the FPAA remained
the same regardless of the limited stipulations; as the stipulations
made clear, whether the evidence ultimately would support the
adjustments was to be determined at trial. We therefore have no reason
to decide whether an “invalid” notice of final partnership
administration adjustment may toll the statutory assessment period.