Court Opinion

ID: 4486551
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:34:31.310958+00
Date Added: 2024-06-11T12:16:30.347984
License: Public Domain

WHALEN, J., dissenting: In this case, the majority decides that the exception for small partnerships, set forth in section 6231(a)(1)(B), is not required by section 6244 to be “extended to and made applicable to subchapter S items” for purposes of the unified S corporation audit and litigation procedures in subchapter D, chapter 63, subtitle F of the Internal Revenue Code, sections 6241-6245 (subchapter D). The majority’s decision hinges on its view that the small partnership exception has no relation to the term “partnership items” as used in subchapter C, chapter 63, subtitle F of the Internal Revenue Code, sections 6221-6233 (subchapter C). Unlike the majority, I believe that the exception for small partnerships has a direct and substantial relationship to the existence of “partnership items” for purposes of subchapter C, and that the majority misconstrues clear statutory provisions in concluding otherwise. Moreover, by misconstruing the term “partnership item,” the single most important term used in subchapter C, the majority opinion not only arrives at the wrong result in this case but it also creates confusion for the application of subchapter C in the future. In fact, neither party to this case advanced the position adopted by the majority, and respondent expressly urged the Court not to adopt it when he argued as follows: In the alternative, if this Court were to reject its prior position, respondent would urge the Court to follow the decision in Arenjay [Corp. v. Commissioner, 920 F.2d 269 (6th Cir. 1991)]. While respondent disagrees with the Fifth Circuit’s determination that the statutory scheme is unambiguous, the respondent agrees with this Court’s determination in Blanco [Investments & Land, Ltd. v. Commissioner, 89 T.C. 1169 (1987),] that some exception does exist in the period prior to the issuance of regulations by Commissioner that explicitly addresses the small S corporation exception. Therefore, respondent disagrees with the approach taken by the United States District Court in Miller v. United States, 710 F. Supp. 1377 (N.D. Ga 1989). Initially, this issue arose because Congress took a shortcut in enacting the uniform procedures for subchapter S items. See Subchapter S Revision Act of 1982, Pub. L. 97-354, 96 Stat. 1691-1692. Congress did not set forth in subchapter D all of the detailed provisions to be applied in the case of “subchapter S items,” as it had done in the case of “partnership items” in subchapter C. Rather, it created only a general framework for such procedures and in section 6244 it provided that certain provisions which “relate to” partnership items should be “extended to and made applicable to subchapter S items.” One category of provisions which Congress incorporated into the unified procedures for subchapter S items is described by section 6244(2) as “so much of the other provisions of this subtitle (i.e., subtitle F) as relate to partnership items.” The majority’s view that the small partnership exception has no relation to the term “partnership items” requires an examination of the nature of that term, as defined by section 6231, and its role in subchapter C. That subchapter was added to the Code by section 402 of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, 96 Stat. 648. It comprises one of the two sets of procedures which alternatively govern the audit and litigation of a partnership’s items of income, gain, loss, deduction, and credit. Maxwell v. Commissioner, 87 T.C. 783, 787 (1986). Subchapter C is applicable to the administrative adjustment and judicial readjustment of partnership items. Under the rules provided therein, adjustments are determined at the partnership level in a unified partnership proceeding, rather than in separate proceedings with the partners. H. Rept. 97-760, at 600 (1982), 1982-2 C.B. 662. The second set of procedures is applicable to the determination and the redetermination of deficiencies. See subchapter B, chapter 63, subtitle F of the Internal Revenue Code, secs. 6211-6216. These are the rules which are generally applicable to taxpayers and, when applied in the context of a deficiency involving an item from a partnership, they require audit and litigation to take place at the partner level. At the center of this dual system of procedures is the term “partnership item.” It is used in subchapter C and elsewhere in subtitle F to distinguish between items of a partnership which are subject to the unified partnership procedures and items which are not, i.e., “nonpartnership items.” Compare pars. (3) and (4) of sec. 6231(a); Saso v. Commissioner, 93 T.C. 730, 734-735 (1989); N.C.F. Energy Partners v. Commissioner, 89 T.C. 741, 746 (1987); Maxwell v. Commissioner, supra at 787. If an item of income, gain, loss, deduction, or credit does not constitute a “partnership item” as defined by section 6231(a)(3), then the special procedural rules set forth in subchapter C do not become operative and the item is subject to the deficiency procedures. See secs. 6501(o)(2), 6504(12), 6511(g), 6512(a)(4), 6515(6), 7422(h), 7485(b). For this purpose, “partnership item” is defined by section 6231(a)(3) as follows: The term “partnership item” means, with respect to a partnership, any item required to be taken into account for the partnership’s taxable year under any provision of subtitle A to the extent regulations prescribed by the Secretary provide that, for purposes of this subtitle, such item is more appropriately determined at the partnership level than at the partner level. [Emphasis supplied.] It is evident that the term “partnership” forms an integral part of the above definition of “partnership item.” Section 6231(a)(1) defines the term “partnership” as follows: (1) Partnership.— (A) In GENERAL. — Except as provided in subparagraph (B), the term “partnership” means any partnership required to file a return under 6031(a). (B) Exception for small partnerships.— (i) In general. — The term “partnership” shall not include any partnership if— (I) such partnership has 10 or fewer partners each of whom is a natural person (other than a nonresident alien) or an estate, and (II) each partner’s share of each partnership item is the same as his share of every other item. For purposes of the preceding sentence, a husband and wife (and their estates) shall be treated as 1 partner. (ii) Election to have subchapter apply. — A partnership (within the meaning of subparagraph (A)) may for any taxable year elect to have clause (i) not apply. Such election shall apply for such taxable year and all subsequent taxable years unless revoked with the consent of the Secretary. Thus, the term “partnership item” contained in paragraph 3 of section 6231(a) incorporates the definition of the term “partnership” contained in paragraph 1 of the same subsection, including the small partnership exception which is an integral part of that definition. Therefore, the term “partnership item,” as used in subchapter C and elsewhere in subtitle F, does not refer to every item of income, gain, loss, deduction, or credit realized by all partnerships. It refers only to those items realized by “partnerships” defined by section 6231(a)(1), that is, partnerships required to file returns under section 6031(a), which are not “small partnerships.” For this purpose, as quoted above, a small partnership is one with 10 or fewer partners, all of whom are natural persons (other than nonresident aliens) or estates and all of whom share items equally. Accordingly, for purposes of subchapter C, no item realized by a “small partnership” can be a “partnership item,” as defined by section 6231(a)(3), unless the partnership elects or has elected to have the exception for small partnerships “not apply.” Sec. 6231(a)(l)(B)(i). Assuming that no such election was made, “items” realized by a small partnership are “nonpartnership items” within the meaning of section 6231(a)(4) and are subject to the procedures for the determination and redetermination of deficiencies. They are not subject to the special procedures set forth in subchapter C, for the administrative adjustment and judicial readjustment at the partnership level. See Z-Tron Computer Research & Development Program v. Commissioner, 91 T.C. 258 (1988); Harrell v. Commissioner, 91 T.C. 242 (1988); Christian v. Commissioner, T.C. Memo. 1990-229. In summary, items of a “small partnership” are not subject to the unified audit and litigation procedures of subchapter C because they are not items of a “partnership” and, therefore, are not “partnership items,” as defined by section 6231(a)(3). In the first case which we encountered on this subject, Blanco Investments & Land, Ltd. v. Commissioner, 89 T.C. 1169 (1987), the Commissioner argued that there was no exception for small S corporations until 1987 when temporary regulations were issued providing an exception for S corporations with five or fewer shareholders. Sec. 301.6241-lT(c)(2), Temporary Proced. & Admin. Regs., 52 Fed. Reg. 3003 (Jan. 30, 1987). We rejected the Commissioner’s argument and concluded that the connection between “the small partnership exception and partnership items is direct and substantial.” Blanco Investments & Land, Ltd. v. Commissioner, supra at 1174. Accordingly, we held that the small partnership exception was grafted onto the subchapter S litigation provisions by section 6244(2) and that “the statute incorporates a small S corporation exception in the subchapter S procedures.” Blanco Investments & Land, Ltd. v. Commissioner, supra at 1174. Because Blanco had one shareholder, we were only required to decide that the “statutory minimum exception for small S corporations is an S corporation with only one shareholder.” Blanco Investments & Land, Ltd. v. Commissioner, supra at 1176. By the time of our second opinion on this subject, 111 West Sixteenth Street Owners, Inc. v. Commissioner, 90 T.C. 1243 (1988), the Commissioner agreed with our reasoning in Blanco and conceded “that the statute mandates an exception for small S corporations.” Thus, both parties to that case agreed that section 6244 mandates an exception for small S corporations, and we were not called upon to revisit our analysis on that point. The parties differed only about the extent of the exception. The taxpayer, an S corporation with three shareholders, argued that the exception must apply to every S corporation having 10 or fewer shareholders, until respondent exercised his authority in section 6244 to provide otherwise by regulation. The Commissioner, on the other hand, argued that, while the statute minimally required an exception for a single shareholder S corporation, the precise number, greater than one, was an administrative matter and should be left to the Commissioner. We agreed with the Commissioner. We later followed that opinion in Twenty-Three Nineteen Creekside, Inc. v. Commissioner, T.C. Memo. 1990-649. In Arenjay Corp. v. Commissioner, 920 F.2d 269 (5th Cir. 1991), revg. and remanding an unreported order of this Court, the Fifth Circuit agreed with our analysis in Blanco that section 6244 grafted the small partnership exception onto the unified procedures for subchapter S items, but it reversed an unreported order of this Court because it disagreed with us about the extent of the exception. The Fifth Circuit reasoned, in my view correctly, that the exception for small S corporations must include S corporations with 10 or fewer shareholders, the same as the small partnership exception in section 6231. The circuit court noted that the statute gave respondent the authority to modify the exception but that he chose not to do so until 1987. The only court to disagree with our holding in Blanco that section 6244 made the small partnership exception applicable to subchapter S items is a District Court in Georgia. Miller v. United States, 710 F. Supp. 1377 (N.D. Ga. 1989). The thrust of the District Court’s opinion is contained in the following excerpt: The [small partnership] provision turns in part on how the partners share partnership items, but the provision itself is applicable only after the partnership items have been identified. The Court therefore concludes that the definition of a small partnership does not “relate to partnership items” in a manner that would make the provision “applicable to subchapter S items” under §6244. [Miller v. United, States, 710 F. Supp. at 1379-1380; emphasis in original.] It is apparent from the above that the District Court’s opinion is based upon the misconception that the small partnership exception is applied only “after” partnership items have been identified. To the contrary, as discussed above, the small partnership exception is an integral part of the definition of “partnership items.” In this case, the majority overrules Blanco and 111 West Sixteenth Street Owners and declares that the Court will not follow the Fifth Circuit’s opinion in Arenjay. The majority takes this action based upon its view that the exception for small partnerships has no relation to the term “partnership items” and therefore, is not a provision of subchapter C which is incorporated by reference into subchapter D. According to the majority, by utilizing the term “partnership items” in section 6244, Congress only intended it to mean “items of income, loss, deductions, and credits” and did not intend “to incorporate the 10-person exemption for small partnerships within the ambit of that term.” Majority op. at 778. The discussion of this point in the majority opinion bears quoting (majority op. at 778): We have reconsidered the “partnership item” aspect of our holding in Blanco, and upon reconsideration, believe we were incorrect in our view that the 10-person exception has any relation to “partnership items.” Rather, that term relates to the provisions of section 6231(a)(3) which define partnership items. * * * In our view, the definition of what relates to a partnership item refers to items of income, deductions, and credits of partnerships, rather than to what constitutes a partnership for TEFRA purposes. In the conference committee report, it is stated: “the tax treatment of items of partnership income, loss, deductions, and credits will be determined at the partnership level in a unified partnership proceeding rather than in separate proceedings with the partners.” H. Rept. 97-760 (Conf.) (1982), 1982-2 C.B. 662. Thus, it is clear that Congress, by utilizing the term “partnership items,” intended it to mean items of income, loss, deductions, and credits. We do not believe that Congress intended it to incorporate .the 10-person exception for small partnerships within the ambit of that term. Thus, the majority opinion concludes that, in enacting subchapter C in TEFRA, Congress did not intend the term “partnership item” to incorporate the small partnership exception within the ambit of that term. I have several difficulties with the reasoning of the majority opinion. First, if the small partnership exception is not incorporated within the term “partnership item,” then there is no small partnership exception, even for purposes of subchapter C. This is because the provisions of subchapter C become operative whenever “partnership items” are at issue. See N.C.F. Energy Partners v. Commissioner, supra; Maxwell v. Commissioner, supra. If Congress did not intend “to incorporate the 10-person exception for small partnerships within the ambit of that term,” then all items of “small partnerships” are subject to the procedures set forth in subchapter C, rather than to the deficiency procedures, despite clear statutory provisions to the contrary. Second, the statement from the TEFRA conference report, quoted by the majority, that the tax treatment of items of partnership income, loss, deductions, and credits will be determined at the partnership level in unified partnership proceedings, does not mean, as the majority suggests, that Congress intended all items to be so determined. Otherwise, all items of every partnership are subject to subchapter C, despite the clear intent of Congress to the contrary. Moreover, both the House and the Senate reports to the Subchapter S Revision Act of 1982, supra, state as follows: The audit provisions are to generally follow the new audit provisions made applicable to partnerships by the Tax Equity and Fiscal Responsibility Act of 1982. * * * However, those rules may be modified by Treasury regulations where appropriate to take account of the differences (whether or not tax related) between a corporation and a partnership. For example, the selection of a person to act on behalf of the corporation in the way the tax matters partner acts on behalf of a partnership must take into account that a corporation has no person to correspond to a general partner * * * the regulations may treat certain corporate items as other than corporate items, for purposes of these audit rules, where special enforcement problems arise. [H. Rept. 97-826 at 24 (1982), 1982-2 C.B. 741; S. Rept. 97-640 at 26 (1982), 1982-2 C.B. 729.] The above statement suggests that Congress envisioned that the unified procedures for subchapter S items would be the same as those for partnership items, unless the Secretary exercises his authority in section 6244 to “modify” those procedures because of differences between corporations and partnerships. It does not suggest that the procedures would be different unless the Secretary exercises his authority in section 6244 to make them the same. Third, the term “partnership item” is the single most important term in subchapter C and governs whether the provisions of subchapter C become operative. It is not reasonable to believe that Congress misused that term in section 6244. Therefore, the use of that term in section 6244 without qualification is sufficient proof that Congress intended to graft the small partnership exception onto subchapter D. Otherwise, Congress could have easily stated in section 6244 that the small partnership exception was not to be extended to or made applicable to subchapter S items or it could have used a term other than “partnership items,” such as the phrase it used in section 7519(d)(2)(A), “partnership’s items described in section 702(a).” Fourth, if the majority is correct that Congress intended the words “partnership items” to mean “items of income, loss, deductions, and credits,” then Congress not only failed to engraft the small partnership exception onto subchapter D but it also failed to engraft section 6231(b), relating to certain events which cause items to cease to be partnership items, onto subchapter D. Thus, until 1987 when respondent promulgated regulations, there were no events which could cause an item to cease to be a subchapter S item. The majority opinion attempts to support its view that the small partnership exception was not grafted onto subchapter D by finding, in section 6241, congressional intent to vest the Secretary with “absolute discretion to issue regulations excepting S corporations from the unified procedures.” Majority op. at 780-781. The majority then questions “whether Congress intended to limit or revoke that discretion by grafting section 6231(a)(1)(B) onto the unified subchapter S procedures by means of section 6244.” Majority op. at 780-781. In the majority’s view, section 6241 would be rendered “meaningless” if the Court were to find a small S corporation exception. The reasoning of the majority is flawed. Section 6241 states as follows: “Except as otherwise provided in regulations prescribed by the Secretary, the tax treatment of any subchapter S item shall be determined at the corporate level.” (Emphasis supplied.) Assuming that Congress intended to graft the small partnership exception onto subchapter D, then it would do so through the term “subchapter S item,” as was done in subchapter C through the term “partnership item.” Therefore, the fact that section 6241 requires “the tax treatment of any subchapter S item” to be determined at the corporate level does not answer the question whether the term “subchapter S items” includes items of small S corporations. For this reason, I submit that the majority’s analysis begs the question whether section 6244 grafted the small partnership exception onto subchapter D. For the foregoing reasons, I submit that the small partnership exception set forth in section 6231(a)(1)(B) was extended to and made applicable to subchapter S items for purposes of the unified S corporation audit and litigation procedures in subchapter D, and that the majority is wrong in holding otherwise. I further submit that the Fifth Circuit’s opinion in Arenjay Corp. v. Commissioner, supra, is correct in holding that the exception for small S corporations applied to S corporations with 10 or fewer shareholders until respondent “modified” the exception in the 1987 regulations. Accordingly, I respectfully dissent.