Court Opinion

ID: 8598775
Source: CourtListenerOpinion
Date Created: 2022-11-23 19:52:36.87179+00
Date Added: 2024-06-11T16:55:06.499965
License: Public Domain

PHILLIPS, Circuit Judge,
dissenting.
I agree that, in the usual case, adjustments to partnership items concerning penalties announced in a Final Partnership Administrative Adjustment (FPAA) aren’t conclusive against partners in partner-level proceedings. This makes sense because TEFRA disallows partners from barging into partnership-level proceedings to assert partner-level defenses. Instead, TEFRA requires partners to await completion of the partnership-level proceedings, and to pay assessed penalties and interest, before asserting partner-level defenses in refund actions.
But this ease is an unusual one. Mr. McNeill is no ordinary partner but is Dul-wich LLC’s managing partner. And Mr. McNeill is also Dulwich’s tax-matters partner, which enabled him to have Dulwich sue in Wyoming federal court to oppose adjustments the IRS had made in the Dul-wich FPAA. And more unusual yet, Mr. McNeill ultimately allowed Dulwich’s challenge to its FPAA’s adjustments to be dismissed. TEFRA takes note of those details and imposes consequences. For instance, upon the dismissal of Dulwich’s FPAA challenge, the FPAA’s findings rise to the level of final and correct findings of the district court itself. Though Mr. McNeill remained free in his penalty-refund action to assert a partner-level defense based on his reasonable cause in pursuing the sham tax scheme, in doing so he faced the FPAA’s already-conclusive determination that he hadn’t acted with reasonable cause or in good faith. In view of this conclusive determination on his refund action’s key question, the district court granted summary judgment in the government’s favor. I agree with the district court’s reasoning and would affirm.
Before examining the applicable law, I think it’s worth circling back to how this case arose and has made its way to us. In its thorough order, the district court recounts in detail Mr. McNeill’s activities leading up to his $7.75 million tax underpayment and $4.59 million assessment for penalties and interest. Soon before participating in the 2002 tax-avoidance activity, Mr. McNeill had served on a board of directors of a corporation that had filed for bankruptcy. There, he dealt with creditors, some of which were distressed-debt investors. Later that year, when Mr. McNeill was set to get an $18 million payout from a company he’d worked for, Mr. McNeill began investigating opportunities to use distressed debt to his advantage. With the help of his attorneys and accountants, Mr. McNeill orchestrated a scheme under which he wrongly claimed about $20 million in losses and correspondingly underpaid his taxes. The district court’s order shows Mr. McNeill to be a financially sophisticated person, fully active in the decisions leading to his tax underpayment and penalty.
Even before filing his 2002 tax return and continuing until now, Mr. McNeill has driven this case. This is unsurprising because Mr. McNeill is Dulwich’s managing partner and tax-matters partner, and, by the end of 2002, its 98% owner. And, in turn, Dulwich owns 99% of Livrpol LLC, the entity that reported over $22 million in losses from the sale of underwater debt instruments, of which Mr. McNeill ultimately claimed $20 million of the losses. That’s how Mr. McNeill set it up.
In December 2006, the IRS issued FPAAs for Dulwich and Livrpol. The two FPAAs contained almost-identical findings. The Dulwich FPAA’s penalty section included a finding that Dulwich and its partners (obviously including Mr. McNeill) “lacked substantial authority for the positions taken, and that the [sic] they did not have a reasonable belief that those positions were more likely than not the correct treatment of such items.” R. vol. 9 at 22. It *1289also included a finding that Dulwich and its partners “did not have reasonable cause and good faith for any of the resulting underpayments.” Id. In March 2007, Mr. McNeill, as Dulwich’s managing partner, filed a petition for readjustment of Dul-wich’s FPAA. in the United States District Court for the District of Wyoming. Importantly, in the Wyoming suit, Mr. McNeill claimed that Dulwich’s partners had “reasonably relied on the advice of their tax advisors and legal counsel in good faith.” Id. at 38.
In May 2008, in the United States District Court for the District of Connecticut, Mr. McNeill (as Dulwich’s managing partner) filed a petition for readjustment of Livrpol’s FPAA (Dulwich was eligible to do so because Livrpol’s tax-matters partner hadn’t filed a challenge, 26 U.S.C. § 6226(b)(1)). Because Livrpol was the top-tier entity that sustained the loss, the government moved to dismiss Dulwich’s Wyoming suit in favor of Livrpol’s Connecticut suit. In response, the Wyoming court stayed Dulwich’s suit until the Li-vrpol suit was finally resolved to see whether that resolution disposed of all the issues in Dulwich’s Wyoming suit. After extensive discovery over two years in Connecticut, Mr. McNeill voluntarily dismissed that suit.1 After the parties advised the Wyoming court that Mr. McNeill had dismissed the Livrpol suit, the Wyoming court gave Mr. McNeill 60 days in which to reopen the challenge to Dulwich’s FPAA. Mr. McNeill chose not to reopen it, leading to the Wyoming court’s dismissing it.
In October 2012, Mr. McNeill filed a claim for a refund of his then-paid penalty and interest. In August 2014, after the IRS hadn’t responded to the claim, Mr. McNeill filed his present action for a Petition for Refund of Penalties and Interest, asserting as a partner-level defense his alleged reasonable cause and good faith. That put front and center the issue we must now decide: Did the Dulwich FPAA’s determinations about Dulwich’s lack of reasonable cause and good faith conclusively establish in Mr. McNeill’s penalty-refund action his own lack of reasonable cause for his tax activity? The district court said yes. It noted that the Dulwich FPAA’s findings became final and correct when Mr. McNeill didn’t reopen Dulwich’s Wyoming case and allowed its dismissal.2 And because the Dulwich FPAA rejected the same reasonable-cause defense Mr. McNeill offered in his penalty-refund action, the district court treated the Dulwich FPAA as conclusively establishing Mr. McNeill’s own lack of reasonable cause too.
In determining that Dulwich’s partnership-level defense based on its reasonable cause for its tax activity must fail, the IRS in its FPAA needed to measure Dulwich’s conduct and state of mind.3 When evaluating a partnership’s conduct and state of *1290mind, the federal circuit courts have done so based on the conduct and state of mind of the partnership’s managing partner. See Southgate Master Fund, L.L.C. ex rel. Montgomery Capital Advisors, LLC v. United States, 659 F.3d 466, 493 n.86 (5th Cir. 2011) (“Where, as here, the reasonable-cause defense is asserted in a partnership-level proceeding, we look to the conduct of the partnership’s managing partners in evaluating the reasonableness of the partnership’s reporting position.”); Am. Boat Co. v. United States, 583 F.3d 471, 479-80 (7th Cir. 2009) (concluding that a partnership could raise its own reasonable-cause defense — separate from any partner-level, reasonable-cause defense— based on its managing partner’s conduct on the partnership’s behalf); Klamath Strategic Inv. Fund ex rel. St. Croix Ventures v. United States, 568 F.3d 537, 546-48 (5th Cir. 2009) (allowing a partnership-level reasonable-cause defense as asserted on the partnership’s behalf by its managing partners); Stobie Creek Invs. LLC v. United States, 608 F.3d 1366, 1381 (Fed. Cir. 2010) (concluding that the partnership could raise a reasonable-cause defense under § 6664(c) “based on the actions of its managing partner”).
Here, the district court determined that Mr. McNeill’s reasonable cause for his tax activity is identical to Dulwich’s reasonable cause. Mr. McNeill hasn’t contested that. In view of this, I agree with the district court that the Dulwich FPAA’s determination that Mr. McNeill lacked reasonable cause for his tax activity is conclusive in Mr. McNeill’s later partner-level refund action. I see nothing in 26 U.S.C. § 6230(c)(4) announcing a rule that all partner-level defenses automatically fully escape the effects and underpinnings of FPAAs’ partnership-level determinations of penalties and interest:
(4) No review of substantive issues
For purposes of any claim or suit under this subsection, the treatment of partnership items on the partnership return ... under the final partnership administrative adjustment ... shall be conclusive. In addition, the determination under the final partnership administrative adjustment ... concerning the applicability of any penalty ... which relates to an adjustment to a partnership item shall also be conclusive. Notwithstanding the preceding sentence, the partner shall be allowed to assert any partner level defenses that may apply ....
26 U.S.C. § 6230(c)(4). I don’t read the third sentence as making the second sentence’s conclusive penalty determinations inconclusive for partner-level defenses in penalty-refund actions. Instead, I read the third sentence as ensuring that partners can always bring partner-level defenses subject to any conclusive determinations being applied in those partner-level proceedings. And many times, partners can prevail at the partner level because none of the FPAA’s conclusive determinations defeat their partner-level defense. For instance, those partners may not have known or done all that the partnership’s managing partner knew and did. And even here, if Mr. McNeill had somehow asserte'd that his own reasonable-cause defense differed from Dulwich’s reasonable-cause defense based on his own conduct and intent, he might still have prevailed despite the conclusive effect TEFRA gives to the FPAA’s penalty determinations.
Nor does the TEFRA regulation guarantee all partners an absolute right to assert reasonable-cause defenses in their partner-level refund actions. It does, however, allow partner-level defenses based on reasonable cause if the defenses are personal to the partner and “cannot be determined at the partnership level.” 26 C.F.R. § 301.6221-l(d). Here, because the reasonable cause Mr. McNeill asserted for Dul-wich and later for himself are the same, *1291Mr. McNeill’s partner-level defense based on his reasonable cause for his tax activity could be and was determined at the Dul-wich partnership level.

. Although Mr. McNeill emphasizes that the Connecticut court’s dismissal order reserved his ability to pursue partner-level defenses of reasonable cause and good faith, that has little bearing here because Mr. McNeill was not Livrpol’s managing partner.

. See 26 U.S.C. § 6226(h) ("If an action brought under this section is dismissed ..., the decision of the court dismissing the action shall be considered as its decision that the notice of final partnership administrative adjustment is correct, and an appropriate order shall be entered in the records of the court.”).

.Although the majority is correct that in years past the government has challenged whether partnerships have statutory authority to make their own reasonable-cause defenses, I don’t see how that matters. The government lost those arguments, and it's now free to enforce the law as the courts have interpreted it. The parties agree that Dulwich — through its tax-matters partner, Mr. McNeill — had a statutory right to challenge its FPAA on reasonable-cause grounds.