Case: 10-50312 Document: 00511260192 Page: 1 Date Filed: 10/12/2010
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT United States Court of Appeals
Fifth Circuit
FILED
October 12, 2010
No. 10-50312 Lyle W. Cayce
Summary Calendar Clerk
J. WINSTON KRAUSE; SHERI S. KRAUSE,
Plaintiffs - Appellants,
v.
UNITED STATES OF AMERICA,
Defendant - Appellee
Appeal from the United States District Court
for the Western District of Texas
USDC No. 1:08-CV-865
Before JOLLY, GARZA, and STEWART, Circuit Judges.
PER CURIAM:*
In this tax refund case, Plaintiffs-Appellants J. Winston and Sheri S.
Krause (“Krause”) appeal the district court’s grant of summary judgment to
Defendant-Appellee the United States. The Krauses argue that the district
court erred when it concluded that, under the Tax Equity and Fiscal
Responsibility Act (“TEFRA”), the court could not consider the couple’s tax
*
Pursuant to 5TH CIR . R. 47.5, the court has determined that this opinion should not
be published and is not precedent except under the limited circumstances set forth in 5TH CIR .
R. 47.5.4.
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refund claims. For the reasons discussed herein, we AFFIRM the district court’s
grant of summary judgment.
A tax attorney and certified public accountant, J. Winston Krause 1 formed
the partnership Krause & Associates Advanced Strategies (“KAAS”) in 2001.
KAAS had one general partner, Krause Holdings, Inc., which was controlled and
owned by Krause. KAAS’s limited partner was Krause & Associates, LP,
Krause’s law firm, of which he was the sole member.
In 2002, Krause created a Son of BOSS (Bond and Option Sale Strategy)
tax shelter,2 which made it appear as though KAAS had suffered a multi-million
dollar loss. Due to the partnership’s tax status, this loss passed through to the
partnership’s limited partner, Krause & Associates which Krause controlled.
Ultimately, the loss appeared on the Krauses’s joint federal income tax returns
in 2002 and 2003.
In 2006, the IRS issued a Final Partnership Administrative Adjustment
(“FPAA”) to KAAS’s general partner, Krause Holdings. The FPAA determined
that KAAS was a hoax and existed for the sole purpose of tax avoidance. It also
stated that the adjustments of partnership items for KAAS, which resulted in
the underpayment of taxes, were due to: “(1) substantial understatements of
income tax, (2) gross valuation misstatement(s), or (3) negligence or disregarded
rules or regulations.” The IRS then issued a Notice of Deficiency, which
indicated Krause owed additional taxes due to the FPAA adjustments. In
1
Named in the Complaint, Sheri S. Krause is a party only because she filed joint tax
returns with her husband for the years in question. J. Winston Krause is responsible for the
acts contested by the IRS.
2
A Son of BOSS tax shelter takes advantage of the way in which a partnership treats
assets and contingent liabilities for tax purposes. This treatment allows a taxpayer to
generate an artificial loss that can be used to offset income from other transactions. See
Kornman & Assocs. Inc. v. United States, 527 F.3d 443, 446 n.2 (5th Cir. 2008). The Internal
Revenue Service (“IRS”) considers these tax shelters an abusive tax practice. I.R.S. Notice
2000-44, 2000-2 C.B. 255.
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addition, the Notice of Deficiency stated that Krause owed $112,466 in penalties
and interest for the gross valuation misstatements.
Krause did not contest the FPAA or the Notice of Deficiency. Krause paid
the additional tax, penalties, and interest, and then filed a refund claim for the
penalties and interest paid. The IRS did not respond and Krause sued.
In his pleadings, Krause asserted that under I.R.C. § 6662(h), the IRS
could not impose an accuracy-related penalty because his understatement of tax
was attributable to the disallowance of a deduction, not a valuation
misstatement as the IRS had alleged. The IRS responded by filing a motion for
summary judgment,3 which argued that Krause’s lawsuit was barred under
TEFRA, I.R.C. §§ 6221-6232, because his refund claim related to penalties, a
partnership-level item that should have been contested by the partnership, not
a partner.
The district court granted the IRS’s summary judgment motion. The court
concluded that it lacked the jurisdiction to consider the case because under §
6230(c)(4), the dispute related to partnership-level items, which could not be
contested once the IRS finalized the FPAA. The court also determined it could
not consider the case because Krause did not raise any partner-level defenses
that would allow the suit to proceed.
Krause appealed. He now argues that the district court mis-characterized
the refund claim and erroneously concluded that TEFRA barred the lawsuit.
We review a district court’s grant of summary judgment de novo, applying
the same standard as the district court. Kornman, 527 F.3d at 450. Summary
judgment is appropriate when pleadings, depositions, discovery answers, and
affidavits reveal no genuine issue of material fact and show that the movant is
3
Krause filed a cross-motion for summary judgment, which the district court denied.
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entitled to judgment as a matter of law. Anderson v. Liberty Lobby, Inc., 477
U.S. 242, 247-48 (1986).
For tax purposes, partnerships are considered pass-through entities that
file informational returns, but do not pay federal income tax. I.R.C. § 6031. This
means that all income, gain, losses, deductions, taxes, and penalties are
allocated among, or assessed against, individual partners, who report the items
on their personal income tax returns. Id. §§ 701-04.
To avoid duplicative litigation stemming from the tax treatment of
partnerships, Congress enacted TEFRA, which creates a unified procedure for
determining the treatment of partnership tax transactions. TEFRA requires
the differentiation between the tax treatment of partnership-level and partner-
level items. Id. § 6221. Partnership items include all items of “income, gain,
loss, deduction, or credit of the partnership,” along with “optional adjustments
to the basis of partnership property pursuant to an election under section 754,”
and “the accounting practices and the legal and factual determinations that
underlie the determination of. . . items of income, credit, gain, loss, deduction,
etc.” Treas. Reg. §§ 301.6231(a)(3)-1(a)(1)(i), (a)(3), (b); see also Weiner v. United
States, 389 F.3d 152, 154 (5th Cir. 2004).
If the IRS seeks to adjust any partnership items, it issues an FPAA to the
partners reflecting adjustments and penalties. I.R.C.§§ 6223, 6225. Although
penalties are determined at the partnership level because of a partnership’s
pass-through tax status, they are assessed against the individual partners, who
ultimately are responsible for payment. Treas. Reg. § 1.6662-5(h).
When the partnership fails to contest the FPAA within a certain time
period, adjustments and penalties become final. I.R.C. §§ 6225, 6230; see also
Randell v. United States 64 F.3d 101, 108 (2d Cir. 1995). After the FPAA
becomes final, a partner is barred from further litigating the adjustment or
penalty because “TEFRA requires the treatment of all partnership items to be
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determined at the partnership level.” Weiner, 389 F. 3d at 154. A partner may,
however, sue for a refund if they assert a reasonable cause defense or argue that
the IRS made a computational error in applying a partnership adjustment.
I.R.C. § 6230(c); Klamath Strategic Inv. Fund v. United States, 568 F.3d 537, 547
(5th Cir. 2009).
Here, Krause asserts that the district court erred in finding that TEFRA
barred the present lawsuit because the penalties were not attributable to
partnership-level items. We disagree.
The penalties assessed under the FPAA were directly attributable to the
fraudulent $2.79 million loss KAAS alleged it incurred when it sold its Canadian
currency. This loss, which passed through to Krause Holdings and then to
Krause, occurred because of the overstated basis KAAS had claimed in the
Canadian currency due to an earlier basis election. Thus, the penalty related to
basis, basis adjustments, and losses, all of which are considered partnership
items under § 6231. See also Treas. Reg. §§ 301.6231(a)(3)-1(a)(1)(i), (a)(3), (b);
Stobie Creek Invs. LLC v. United States, 608 F.3d 1366, 1380-81 (Fed. Cir. 2010)
(holding that court could consider case because partnership had contested
adjustment of partnership-level items prior to finalization of FPAA.)
Further, the refund sought by Krause relates to penalties and penalty-
related interest that are associated with partnership-level items, both of which
are in and of themselves considered partnership-level items. I.R.C. §§ 6221,
6230(c)(4). In this regard, the Code is clear: these are items that must be
contested before the IRS finalizes an FPAA. The district court did not err by
concluding that it could not consider Krause’s refund claims.
To bolster his argument that a gross valuation penalty may not be imposed
in circumstances such as this case, Krause relies upon Heasley v. Comm’r, 902
F.2d 380, 381-84 (5th Cir. 1990) and Todd v. Comm’r, 862 F.2d 540, 542 (5th Cir.
1988). He urges us to find that the district court’s ruling misinterpreted the
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holdings of Heasley and Todd. These cases, like this matter, involved questions
about tax-related penalties. Their holdings are inapplicable, however, because
these cases did not involve questions about partnerships, partnership
transactions, or more importantly, TEFRA.
Krause also argues that the IRS erroneously enacted the penalty because
the alleged misvaluation relates to a foreign currency option that Krause did not
contribute to the partnership. Therefore, Krause asserts, the misvaluation in
question was not a partnership-level item. To fully address this argument we
must first ignore the fact that this argument directly relates to the penalties
imposed by an FPAA, which TEFRA specifically considers as partnership-level
items that cannot be contested at the partner-level. These facts aside, Krause’s
contention is still incorrect.
Although Krause did not contribute the foreign currency option in question
to the partnership, it played a significant role in Krause’s tax chicanery. The
record is clear– Krause’s tax-treatment of this option was entwined with his tax-
treatment of the foreign currency option that he contributed to KAAS. In
addition, the FPAA specifically stated that options were “in substance a single
integrated financial transaction.” And, because of that, the FPAA disallowed the
purported loss. Thus, what lies at the core of Krause’s argument is the FPAA’s
characterization and treatment of purported losses and gains. And, as we stated
earlier, gains, losses, and penalties are all partnership-level items, which must
be contested before the FPAA is finalized.
For the foregoing reasons, we find the district court did not err and we
AFFIRM the district court’s grant of summary judgment to the United States.
6