T.C. Memo. 2007-81
UNITED STATES TAX COURT
ROBERT J. GOLDBERG AND BRADLEY A. MORGAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7800-05. Filed April 5, 2007.
John O. Kent and Dennis N. Brager, for petitioners.
S. Katy Lin, for respondent.
MEMORANDUM OPINION
GOEKE, Judge: This matter is before the Court on
respondent’s motion to dismiss for lack of jurisdiction. At
issue is whether this Court has jurisdiction over items
respondent adjusted in the notice of deficiency relating to
Bradley A. Morgan’s (petitioner) investment in a partnership. We
do not decide the issue with respect to the majority of the items
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because of the uncertainty of whether TEFRA procedures in
sections 6221-6234 apply to those items.1 See Tax Equity and
Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248, secs.
402-407(a), 96 Stat. 648. However, we have jurisdiction over one
of the items adjusted regardless of whether TEFRA applies.
Therefore, respondent’s motion will be denied.
Background
Petitioners are husband and wife. Their residence at the
time of filing the petition was in Hermosa Beach, California.
Respondent issued a notice of deficiency for the taxable year
2001 to petitioners on January 27, 2005. The deficiency notice
contained adjustments arising from petitioner’s interest in a
partnership called Alameda Investments, L.L.C. (Alameda). On its
Form 1065, U.S. Return of Partnership Income, for 2001 Alameda
listed an ordinary loss of $12,279 from trade or business
activities. On petitioner’s Schedule K-1, Partner’s Share of
Income, Credits, Deductions, etc., petitioner was identified as
the 99-percent owner of Alameda. A separate Schedule K-1
identified Clarion Forex Advisors XV, LLC (Clarion Forex) as the
1-percent partner. The Schedule K-1 for petitioner allocated to
her, as her distributive share, 100 percent of the partnership’s
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended.
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loss of $12,279.2 Petitioners claimed the loss of $12,279 on
their Form 1040, U.S. Individual Income Tax Return, as well as a
loss of $1,657,609 based on a sale of securities distributed to
petitioner by Alameda. In addition, petitioners claimed a
$125,000 deduction for legal, accounting, consulting, and
advisory fees. Respondent issued a notice of final partnership
administrative adjustment (FPAA) for Alameda concurrently with
the notice of deficiency. In the FPAA, respondent determined
that Alameda was a sham and that none of the deductions that the
partnership claimed on its partnership return were allowable.
The notice of deficiency issued to petitioners stated the
following:
1. The deduction of $12,279 shown on your 2001 tax
return as your reported share of the loss purportedly
sustained by Alameda Investments, LLC is disallowed
because you have failed to establish (1) that the
purported loss was sustained in any amount by either
you or any entity in which you held an interest, (2)
that the transaction purportedly generating the loss in
question was entered into for profit within the meaning
of I.R.C. section 165(c)(2), or (3) that any portion of
the loss in question is allowable as a deduction under
any other provision of the Internal Revenue Code. You
have also failed to establish that, even if loss was
sustained and would otherwise be deducible, any
deduction relating to the loss is not specifically
limited or disallowed by any provision of the Internal
Revenue Code, including without limitation §§ 165, 212,
704(d), or 465.
2
Although petitioner’s Schedule K-1, Partner’s Share of
Income, Credits, Deductions, etc., identifies her as the 99-
percent partner for part of the year, her share in the profits
and losses is listed as 100 percent.
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2. It is further determined that the loss deduction
claimed on your 2001 federal income tax return is
disallowed because Alameda Investments, LLC with
reference to which you determined basis in the
derivative security sold is a sham and should not be
recognized for federal income tax purposes.
3. It is further determined that the deduction of
$1,657,609 claimed as a loss for the tax year 2001 is
disallowed because you have failed to establish the
basis in the partnership interest in Alameda
Investments, LLC was greater than zero. You have also
failed to establish the basis in the derivative
securities sold or disposed of was greater than zero
($0).
4. It is further determined that the deduction for
the loss claimed is disallowed to the extent that the
provisions of Chapter 1, Subchapter K of the Internal
Revenue Code were used to calculate basis in the
Property sold. Alameda Investments, LLC was formed or
availed of in connection with a transaction or
transactions in taxable year 2001 a principal purpose
of which was to reduce substantially the present value
of your federal tax liability in a manner that is
inconsistent with the intent of Subchapter K of the
Internal Revenue Code. The manner in which you and
Alameda Investments, LLC accounted for the derivative
securities transaction in question violated the intent
of Subchapter K. Accordingly, the parties’ accounting
for the transaction should be adjusted, pursuant to the
authority contained in Treas. Reg. § 1.701-2, to
achieve results that are consistent with the intent of
Subchapter K by ignoring the existence of the
partnership, or treating transactions purportedly
engaged in by the partnership as engaged in directly by
the purported partners.
5. It is further determined, in the alternative, that
the loss claimed on your 2001 federal income tax return
should be decreased to reflect the limitation on your
adjusted basis in your partnership interest resulting
from your contribution of your position(s) in the
securities transaction(s) to the partnership, pursuant
to Treas. Reg. § 1.752-6T.
6. It is further determined, in the alternative, that the
loss claimed on your 2001 federal income tax return should
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be decreased in the amount of $1,657,609 to limit any loss
incurred by you and the partnership in connection with the
security transaction to the amount actually at risk in the
transaction, pursuant to Internal Revenue Code §465(b)(4).
7. It is further determined that no deduction is
allowed for any legal, accounting, consulting and
advisory fees claimed in the amount of $125,000 since
you failed to establish that such expenditures were
incurred, and if incurred, are deductible under any
provision of the Internal Revenue Code, including but
not limited to Internal Revenue Code §§ 183 and 212.
Alameda and petitioners filed separate petitions with this
Court. Alameda’s petition was filed at docket No. 7810-05. On
January 29, 2007, this Court entered a stipulated decision in the
case at docket No. 7810-05.
Petitioners’ petition assigned error to all of the
determinations respondent made in his notice of deficiency.
Paragraph 4(g) of petitioners’ petition stated:
The Commissioner erred in his determination that
no deduction is allowed for any legal, accounting,
consulting and advisory fees, claimed in the amount of
$125,000, on the grounds that Petitioners failed to
establish that such expenditures were incurred, and if
incurred, are deductible under any provision of the
Internal Revenue Code.
On September 14, 2006, respondent moved to dismiss the case
herein for lack of jurisdiction upon the ground that the notice
of deficiency was invalid under section 6225. On November 3,
2006, petitioners notified the Court that they did not object to
respondent’s motion. On November 14, 2006, the Court issued an
order to the parties requesting responses, via a written status
report, to the following: (1) Why Alameda does not fall under
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the small partnership exception of section 6231(a)(1)(B)(i); and
(2) the parties’ positions regarding the Court’s jurisdiction
over the losses petitioners claimed on their returns and the
deduction petitioners claimed for legal, accounting, consulting,
and advisory fees. In their separate status reports, the parties
responded: (1) One of the partners in Alameda is Clarion Forex,
which is a disregarded entity and therefore disqualifies Alameda
from the small partnership exception; and (2) the Court does not
have jurisdiction over the losses or the deductions petitioners
claimed on their return because those losses flow directly from
partnership items, and since the partnership items had not yet
been determined at the partnership level when respondent issued
the notice of deficiency, this Court does not have jurisdiction
over any of the items in the notice. In addition, petitioners
conceded that they were not allowed a deduction for legal,
accounting, consulting, and advisory fees.
Discussion
Applicability of TEFRA
TEFRA provisions divide disputes arising from “partnership
items” from those arising from “nonpartnership items”. Maxwell
v. Commissioner, 87 T.C. 783, 787 (1986). Section 6231(a)(3)
provides:
(3) Partnership item.--* * * 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
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the Secretary provide that, for purposes of this
subtitle, such item is more appropriately determined at
the partnership level than at the partner level.
If the tax treatment of a partnership item is at issue, the
statute generally requires the matter to be resolved at the
partnership level. Sec. 6221; Maxwell v. Commissioner, supra at
787-788. Further, deficiencies attributable to “affected items”
may not be assessed until the related partnership proceeding is
completed. See sec. 6225(a); GAF Corp. & Subs. v. Commissioner,
114 T.C. 519, 525 (2000). An affected item is “any item to the
extent such item is affected by a partnership item.” Sec.
6231(a)(5). An affected item is peculiar to a partner’s own tax
posture. Maxwell v. Commissioner, supra at 790.
Respondent asserts that all the adjustments in the notice of
deficiency consist of affected items that depend on partnership-
level determinations. Respondent asserts that the adjustments in
the notice of deficiency relating to petitioners’ share of the
partnership loss is a partnership item under section
301.6231(a)(3)-1(a)(1)(i), Proced. & Admin. Regs. Respondent
further argues that adjustment for the amount of loss petitioners
sustained for their sale of securities depends on a determination
of petitioners’ basis in Alameda, which petitioners used to
compute their basis in the securities under section 732(b).
Under section 301.6231(a)(5)-1(b), Proced. & Admin. Regs., the
basis of a partner’s interest in a partnership is an affected
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item to the extent it is not a partnership item. A partner
generally may not compute his affected items before a related
partnership-level proceeding is completed. Dial USA, Inc. v.
Commissioner, 95 T.C. 1 (1990). We lack jurisdiction over
affected items in a notice of deficiency that was issued before
the completion of the related TEFRA partnership proceedings. GAF
v. Commissioner, supra at 525. Since respondent issued the
notice of deficiency before the decision in the related TEFRA
proceeding was entered, respondent concludes that we do not have
jurisdiction.
We do not have sufficient information to determine whether
we have jurisdiction over the above-described items. The record
does not give us enough information to determine whether TEFRA
applies. The Schedules K-1 show that petitioner and Clarion
Forex were listed as partners of Alameda. However, since there
are fewer than five partners of Alameda, the small-partnership
exception to TEFRA under section 6231(a)(1)(B) may apply.
Section 6231(a)(1)(B) excepts certain small partnerships
from TEFRA procedures. If TEFRA procedures do not apply, they do
not restrict the Commissioner from determining deficiencies in
the income tax of partners. Section 6231(a)(1)(B) provides:
(B) Exception for small partnerships.--
(i) In general.--The term “partnership” shall not
include any partnership having 10 or fewer partners
each of whom is an individual (other than a nonresident
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alien), a C corporation, or an estate of a deceased
partner. 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.
Respondent claims that Clarion Forex disqualifies Alameda
from the small partnership exception because it is a disregarded
entity under section 301.7701-3(b)(1)(ii), Proced. & Admin Regs.
Respondent takes the position that a disregarded entity is a
pass-through partner as defined in section 6231(a)(9).3 See Rev.
Rul. 2004-88, 2004-2 C.B. 165. The small partnership exception
is not applicable where any partner in the partnership is a
“pass-through partner”. See sec. 301.6231(a)(1)-1(a)(2), Proced.
& Admin. Regs. However, neither of the parties identified to
whom the interest in Clarion Forex passes through. Nor do we
have sufficient evidence of Clarion Forex’s status as a
disregarded entity. Therefore, we specifically do not determine
whether TEFRA applies to the adjustments.
However, with respect to the adjustments relating to the
deduction for legal, accounting, consulting, and advisory fees,
3
Sec. 6231(a)(9) provides that “The term ‘pass-thru partner’
means a partnership, estate, trust, S corporation, nominee, or
other similar person through whom other persons hold an interest
in the partnership with respect to which proceedings under this
subchapter are conducted.”
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we retain jurisdiction regardless of whether TEFRA applies.
Paragraph 4(g) of the petition assigned error to the adjustment
in paragraph 7 of the explanation of items in the notice of
deficiency denying petitioners a deduction under section 183 or
section 212 for any legal, accounting, consulting, and advisory
fees for the taxable year 2001. These items are neither
partnership items nor affected items. They were claimed by
petitioners on their individual return, not by the partnership on
its partnership return.
Respondent contends that the items referred to in paragraph
4(g) of petitioners’ petition are affected items. Respondent
reasons that the deduction was disallowed because Alameda and the
partnership transaction at issue were shams, and that the
determination of whether a partnership is a sham is a partnership
item. Respondent cites River City Ranches #1 Ltd. v.
Commissioner, 401 F.3d 1136, 1144 (9th Cir. 2005), affg. in part
and revg. in part T.C. Memo. 2003-150, and Andantech L.L.C. v.
Commissioner, 331 F.3d 972, 981 (D.C. Cir. 2003), affg. in part
and remanding T.C. Memo. 2002-97, to support his assertion.
We find that River City Ranches, which dealt with the
penalty-interest provision of section 6621(c), is
distinguishable. The issue of whether the partnership’s
transactions were shams directly affected the penalty-interest
issue. In this case, even if the Court were to determine that
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the partnership or the transaction the partnership engaged in was
a sham, that would not necessarily mean petitioners are not
entitled to an individual deduction for legal, accounting,
consulting, and advisory fees. Further, Andantech is
inapplicable because neither this Court nor the Court of Appeals
for the D.C. Circuit resolved the issue of whether a partner’s
individual deductions would be classified as a partnership item
or an affected item in the event that the transaction at issue
were declared to be a sham.
We find that even if the partnership is a sham, we still
retain jurisdiction over the deduction for legal, accounting,
consulting, and advisory fees. The result would be the same even
if TEFRA applied to the partnership. The notice of deficiency
disallows the deduction at the individual level. Petitioners
claimed the deduction on their individual return. The deduction
was not claimed on the partnership return nor claimed by
petitioners as their distributive share of any deduction on the
partnership return. The disallowance of the deduction at the
individual level did not flow from a deduction disallowed at the
partnership level, nor is the legality of the deduction at the
individual level necessarily affected by a determination at the
partnership level. Petitioners concede that they are not
entitled to the deduction for the items to which paragraph 4(g)
of the petition refers. It is irrelevant whether petitioners
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concede that they are not entitled to the disputed deduction.
Such a concession does not deprive us of jurisdiction. See LTV
Corp. v. Commissioner, 64 T.C. 589, 591 (1975).
Thus, we conclude that we do have jurisdiction to
redetermine petitioners’ deduction for legal, accounting,
consulting, and advisory fees. Therefore, respondent’s motion to
dismiss for lack of jurisdiction will be denied.
To reflect the foregoing,
An appropriate order will be
issued.