131 T.C. No. 18
UNITED STATES TAX COURT
NEW MILLENNIUM TRADING, L.L.C., AJF-1, L.L.C., TAX MATTERS
PARTNER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3439-06. Filed December 22, 2008.
P challenges adjustments in a notice of final
partnership administrative adjustment (FPAA) issued to NM.
The FPAA, in part, determined that penalties under sec.
6662, I.R.C., were applicable. P, wanting to raise partner-
level defenses to the determination of sec. 6662, I.R.C.,
penalties if we should sustain R’s substantive
determinations in this partnership-level proceeding, has
filed a motion for partial summary judgment to declare that
sec. 301.6221-1T(c) and (d), Temporary Proced. & Admin.
Regs., 64 Fed. Reg. 3838 (Jan. 26, 1999), is invalid, or, in
the event we hold the regulation valid, that it does not
apply to the instant proceeding.
Held: Sec. 301.6221-1T(c) and (d), Temporary Proced. &
Admin. Regs., supra, is valid.
Held, further: Sec. 301.6221-1T(c) and (d), Temporary
Proced. & Admin. Regs., supra, applies to the instant
- 2 -
proceeding, so that partner-level defenses cannot be
asserted in this partnership proceeding if we should sustain
R’s substantive determinations.
Thomas A. Cullinan and Julie P. Bowling, for petitioner.
James R. Rich, for respondent.
OPINION
GOEKE, Judge: This case is before the Court on petitioner’s
motion for partial summary judgment filed pursuant to Rule 121.1
Petitioner asks that we hold section 301.6221-1T(c) and (d),
Temporary Proced. & Admin. Regs., 64 Fed. Reg. 3838 (Jan. 26,
1999), invalid, or if valid, inapplicable. For the reasons
stated herein, we will deny petitioner’s motion in both respects.
Background
The following information is stated for purposes of this
Opinion only; this case has yet to be tried on the merits.
On May 20, 1999, Andrew Filipowski established the AJF-1
Trust (trust) by a declaration of trust. Mr. Filipowski was the
grantor, cotrustee, and sole beneficiary of the trust and was
considered its owner for income tax purposes under sections 671
through 678.
1
Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code (Code).
- 3 -
On July 29, 1999, AJF-1, L.L.C. (AJF-1), was formed by the
filing of a certificate of formation with the State of Illinois.
The trust was the sole member of AJF-1. AJF-1 was disregarded as
an entity separate from its owner for Federal income tax purposes
pursuant to section 301.7701-3(b)(ii), Proced. & Admin. Regs.
In August 1999 AJF-1 opened a trading account with AIG
International (AIG). On August 19, 1999, AJF-1 entered into two
transactions with AIG: (1) AJF-1 purchased a European-style call
option on the euro for a premium of $120 million; and (2) on that
same day, AJF-1 sold to AIG a European-style call option on the
euro for a premium of $118.8 million (collectively, the euro
options). AJF-1 paid the $1.2 million net premium of the euro
options to AIG.
New Millennium Trading, L.L.C. (New Millennium), was formed
on August 6, 1999, under the laws of the State of Delaware. New
Millennium’s original members were Banque Safra-Luxembourg, S.A.
(Banque Safra), Fidulux Management, Inc. (Fidulux), and Shakti
Advisors, L.L.C. (Shakti). Banque Safra, Fidelux, and Shakti
contributed $300,000, $150,000, and $20,000, respectively, to New
Millennium for their partnership interests.
AJF-1 joined New Millennium in September 1999. AJF-1
contributed $600,000 and entered into an Assignment and
Assumption Agreement dated September 30, 1999, whereby New
Millennium assumed the rights and obligations of the euro
- 4 -
options. New Millennium valued AJF-1’s total contribution at
$1,772,417.
After joining New Millennium, AJF-1 had a partnership
interest of 79.04-percent, while Shakti, Fidelux, and Banque
Safra had interests of .89 percent, 6.69 percent, and 13.38
percent, respectively.
AJF-1 requested withdrawal from New Millennium by letter
dated December 2, 1999. AJF-1 was deemed to have withdrawn on
December 15, 1999. On December 20, 1999, New Millennium
distributed 617,664 euro and 21,454 shares of Xerox Corp. stock
valued at $1,068,388.40 to AJF-1. This distribution was made to
redeem AJF-1’s account. On December 23, 1999 AJF-1 sold all the
Xerox Corp. stock and 530,000 of the 617,664 euro, for $464,191
and $537,420, respectively.
On September 21, 2005 Respondent issued a notice of final
partnership administrative adjustment (FPAA) to New Millennium.
The FPAA made a number of adjustments: (1) It disallowed New
Millennium’s claimed operating loss of $669,206 and other
deductions of $18,712, and (2) it decreased to zero the capital
contributions, and distributions of property other than money
accounts. The FPAA indicated these changes in chart form. Each
adjustment was shown in a chart with an “adjustment,” “as
reported,” and “corrected” box accompanying each individual
adjustment. The chart included numerical figures for each of the
- 5 -
above adjustments but showed asterisks instead of numerical
figures as to outside partnership basis.
In addition, respondent made a number of determinations
regarding New Millennium and its partners under the title of
“EXHIBIT A”. This explanation of items is attached hereto as an
appendix. These explanations alleged in pertinent part that:
(1) New Millennium was not established as a partnership in fact;
(2) if New Millennium existed in fact, it was entered into solely
for tax avoidance purposes; (3) New Millennium was a sham, lacked
economic substance, and was entered into to decrease its
partners’ tax liabilities in a manner inconsistent with chapter
1, subchapter K of the Code; (4) neither New Millennium nor its
partners entered into the euro options with a profit motive; (5)
neither New Millennium nor its partners have established bases in
their partnership interests greater than zero; and (6) penalties
under section 6662 are applicable.
On February 16, 2006, petitioner petitioned this Court,
alleging that respondent’s determinations were erroneous. On
February 6, 2008, petitioner filed a motion for partial summary
judgment (motion). On March 12, 2008, respondent filed his
response thereto, and on April 25, 2008, petitioner filed a
memorandum in support of its motion. A hearing was held on
petitioner’s motion on June 27, 2008, during the Court’s trial
session in Washington, D.C.
- 6 -
Petitioner filed concurrently with the motion a motion to
dismiss for lack of jurisdiction as to adjustments to the
partners’ outside bases and penalties (motion to dismiss). We
have recently denied by order petitioner’s motion to dismiss
because under Petaluma FX Partners, L.L.C. v. Commissioner, 131
T.C. (2008), the extent of our jurisdiction over outside
basis and the applicability of penalties determined in the FPAA
cannot be established until after a trial on the merits to decide
whether New Millennium should be respected as a partnership for
tax purposes.
Discussion
I. Motion for Summary Judgment
Summary judgment is intended to expedite litigation and
avoid unnecessary and expensive trials. Fla. Peach Corp. v.
Commissioner, 90 T.C. 678, 681 (1988). The Court may grant
summary judgment where there is no genuine issue of material
fact and a decision may be rendered as a matter of law. Rule
121(a) and (b); Sundstrand Corp. v. Commissioner, 98 T.C. 518,
520 (1992), affd. 17 F.3d 965 (7th Cir. 1994). The moving party
bears the burden of proving that there is no genuine issue of
material fact, and the Court will view any factual material and
inferences in the light most favorable to the nonmoving party.
Dahlstrom v. Commissioner, 85 T.C. 812, 821 (1985). Rule 121(d)
provides that where the moving party properly makes and supports
- 7 -
a motion for summary judgment, “an adverse party may not rest
upon the mere allegations or denials of such party’s pleading”
but must set forth specific facts, by affidavits or otherwise,
“showing that there is a genuine issue for trial.” The matter
before us is ripe for summary judgment.
Whether the regulation at issue is valid is strictly a
question of law. Although this Court has applied this regulation
to prevent partners from raising partner-level defenses in a
partnership proceeding, see Fears v. Commissioner, 129 T.C. 8
(2007); Santa Monica Pictures, L.L.C. v. Commissioner, T.C. Memo.
2005-104, we have not ruled squarely on the validity of section
301.6221-1T(c) and (d), Temporary Proced. & Admin. Regs., 64 Fed.
Reg. 3838 (Jan. 26, 1999).
II. TEFRA Procedures
Partnerships do not pay Federal income taxes, but they are
required to file annual information returns reporting the
partners’ distributive shares of income, deductions, and other
tax items. Secs. 701, 6031. The individual partners then report
their distributive shares of the tax items on their Federal
income tax returns. Secs. 701-704.
To remove the substantial administrative burden occasioned
by duplicative audits and litigation and to provide consistent
treatment of partnership items among partners in the same
partnership, Congress enacted the unified audit and litigation
- 8 -
procedures of the Tax Equity and Fiscal Responsibility Act of
1982 (TEFRA), Pub. L. 97-248, sec. 402, 96 Stat. 648. See
Randell v. United States, 64 F.3d 101, 103 (2d Cir. 1995); H.
Conf. Rept. 97-760, at 599-600 (1982), 1982-2 C.B. 600, 662-663.
Under TEFRA, all partnership items are determined in a
single partnership-level proceeding. Sec. 6226; see also Randell
v. United States, supra at 103. The determinations of
partnership items in partnership-level proceedings are binding on
the partners and may not be challenged in subsequent partner-
level proceedings. See secs. 6230(c)(4), 7422(h). Thus the
courts need not redecide the same issues with each partner of the
partnership.
TEFRA also allows for the imposition during the partnership-
level proceeding of penalties on adjustments to partnership
items. Sec. 6221; see also Santa Monica Pictures, L.L.C. v.
Commissioner, supra. Before the 1997 amendments, TEFRA provided
for the determination of all penalties at the partner level.
N.C.F. Energy Partners v. Commissioner, 89 T.C. 741, 744-745
(1987). Amendments to TEFRA in 1997 changed this structure and
provided for the imposition of penalties at the partnership
level. After amendment, section 6221 provides:
Except as otherwise provided * * * the tax treatment of
any partnership item (and the applicability of any penalty,
addition to tax, or additional amount which relates to an
adjustment to a partnership item) shall be determined at the
partnership level.
- 9 -
If a partnership item is adjusted, a penalty, if applicable, can
be imposed on that adjustment during the TEFRA proceeding. If
the court is considering the imposition of penalties, it may
consider the reasonable cause defenses of the partnership. See
sec. 6664(c); Whitehouse Hotel Ltd. Pship. v. Commissioner, 131
T.C. (2008); Santa Monica Pictures, L.L.C. v. Commissioner,
supra; Jade Trading, L.L.C. v. United States, 80 Fed. Cl. 11, 59-
60 (2007); Stobie Creek Invs. L.L.C., v. United States (Stobie
Creek II), 82 Fed. Cl. 636, (2008); Stobie Creek Invs., L.L.C. v.
United States (Stobie Creek I), 81 Fed. Cl. 358 (2008). If a
penalty was imposed at the partnership level during the TEFRA
proceeding, the Commissioner may assess that amount without
issuing a notice of deficiency. Sec. 6230(a)(1); N.C.F. Energy
Partners v. Commissioner, supra at 744; sec. 301.6231(a)(6)-
1T(a), Temporary Proced. & Admin. Regs., 64 Fed. Reg. 3840 (Jan.
26, 1999).
If a partner believes that a penalty was incorrectly
assessed against him following a determination at the partnership
level, section 6230(c)(1)(C) provides that the partner may file a
claim for refund on the grounds that the Secretary erroneously
imposed any penalty, addition to tax, or additional amount which
relates to an adjustment to a partnership item. Section
6230(c)(4) details what can be contested during a refund claim
filed under section 6230(c)(1). Pursuant to section 6230(c)(4),
- 10 -
the determination under the FPAA or under the decision of a court
concerning the applicability of any penalty relating to an
adjustment to a partnership item shall be deemed conclusive;
however, “the partner shall be allowed to assert any partner
level defenses that may apply or to challenge the amount of the
computational adjustment.” Read together, sections 6221 and 6230
provide that a partner is allowed to raise partner-level defenses
to a penalty imposed during a partnership-level proceeding only
in a refund action later filed under section 6230(c).
If a partner has an increased liability stemming from an
affected item or a computational adjustment that requires a
factual determination at the partner level, the normal deficiency
procedures outlined in sections 6212 and 6213 apply. Sec.
6230(a); sec. 301.6231(a)(6)-1T(a)(2), Temporary Proced. & Admin.
Regs., supra; see Domulewicz v. Commissioner, 129 T.C. 11, 17-19
(2007).
Petitioner’s motion asks this Court to rule that: (1)
Section 301.6221-1T(c) and (d) Temporary Proced. & Admin. Regs.,
supra,2 is invalid because it was promulgated without authority
and conflicts with Congress’s statutory scheme, or in the
alternative should we find that the regulation is valid, (2)
2
Although temporary during the year at issue, sec. 301.6221-
1T(c) and (d), Temporary Proced. & Admin. Regs., 64 Fed. Reg.
3838 (Jan. 26, 1999), was made final and applicable to
partnership taxable years beginning on or after Oct. 4, 2001.
Sec. 301.6221-1(f), Proced. & Admin. Regs.
- 11 -
section 301.6221-1T(c) and (d), Temporary Proced. & Admin. Regs.,
supra, does not apply to this case.
Section 301.6221-1T(c) and (d), Temporary Proced. & Admin.
Regs., supra, was promulgated pursuant to the Secretary’s
authority under section 7805(a). Section 7805(a) provides:
SEC. 7805(a). Authorization.--Except where such
authority is expressly given by this title to any person
other than an officer or employee of the Treasury
Department, the Secretary shall prescribe all needful rules
and regulations for the enforcement of this title, including
all rules and regulations as may be necessary by reason of
any alteration of law in relation to internal revenue.
Section 301.6221-1T(c), Temporary Proced. & Admin. Regs., supra,
provides:
(c) Penalties determined at partnership level
(partnership taxable years ending after August 5, 1997).
Any penalty, addition to tax, or additional amount that
relates to an adjustment to a partnership item shall be
determined at the partnership level. Partner level defenses
to such items can only be asserted through refund actions
following assessment and payment. Assessment of any
penalty, addition to tax, or additional amount that relates
to an adjustment to a partnership item shall be made based
on partnership-level determinations. Partnership-level
determinations include all the legal and factual
determinations that underlie the determination of any
penalty, addition to tax, or additional amount, other than
partner level defenses specified in paragraph (d) of this
section. [Emphasis added.]
Section 301.6221-1T(d), Temporary Proced. & Admin. Regs., supra,
provides:
(d) Partner-level defenses. Partner-level defenses to
any penalty, addition to tax, or additional amount that
relates to an adjustment to a partnership item, may not be
asserted in the partnership-level proceeding, but may be
asserted through separate refund actions following
assessment and payment. See section 6230(c)(4). Partner
- 12 -
level defenses are limited to those that are personal to the
partner or are dependant upon the partner’s separate return,
and cannot be determined at the partnership level. Examples
of these determinations are whether any applicable threshold
underpayment of tax has been met with respect to the partner
or whether the partner has met the criteria of section
6664(b) (penalties applicable only where return is filed),
or section 6664(c)(1) (reasonable cause exception) subject
to partnership level determinations as to the applicability
of section 6664(c)(2). [Emphasis added.]
Petitioner advances two arguments for declaring the
regulation invalid: (1) Congress gave the Tax Court jurisdiction
to consider partner-level defenses but the Secretary exceeded his
authority in promulgating a regulation stripping the Court of
that jurisdiction; and (2) even if the Secretary had
authorization to issue section 301.6221-1T(c) and (d), Temporary
Proced. & Admin. Regs., supra, the regulation is invalid because
it both conflicts with and is an unreasonable interpretation of
section 6221.
III. Tax Court Jurisdiction To Consider Partner Defenses
Petitioner first argues that Congress gave the Tax Court
jurisdiction to consider partner-level defenses during a
partnership-level proceeding but that the Secretary exceeded his
statutory authority in promulgating a regulation removing that
authority.
Petitioner argues that the Secretary exceeded his authority
in promulgating this regulation because the Secretary issued
section 301.6221-1T(c) and (d), Temporary Proced. & Admin. Regs.,
- 13 -
supra, pursuant to section 7805, which is a general grant of
authority.
Petitioner argues that an administrative agency cannot strip
a court of jurisdiction on the basis of a general grant of
authority but instead needs a specific grant of authority from
Congress in order to do so. Petitioner contends that when a
court reviews a regulation that strips the court of jurisdiction,
the administrative agency is not entitled to any deference
because the question of a court’s jurisdiction is outside agency
expertise. Petitioner draws support for this argument from Adams
Fruit Co. v. Barrett, 494 U.S. 638 (1990), and Nagahi v. INS, 219
F.3d 1166 (10th Cir. 2000).
In Adams Fruit Co. v. Barrett, supra at 649, the Supreme
Court rejected a Department of Labor interpretation of the
Migrant and Seasonal Agricultural Worker Protection Act (the act)
determining that a migrant worker did not have a private right of
action under the act if a State workers’ compensation benefit was
available to the worker. The Court stated that the delegation of
authority to promulgate regulations on which the Department of
Labor relied did--
not empower the Secretary to regulate the scope of the
judicial power vested by the statute. Although agency
determinations within the scope of delegated authority are
entitled to deference, it is fundamental “that an agency may
not bootstrap itself into an area in which it has no
jurisdiction.” * * *
- 14 -
Id. at 650 (quoting Fed. Maritime Commn. v. Seatrain Lines, Inc.,
411 U.S. 726, 745 (1973)).
In Nagahi v. INS, supra at 1167, the Court of Appeals was
asked to consider a regulation promulgated by the Immigration and
Naturalization Service that imposed a 120-day filing requirement
for the start of a suit challenging an INS determination. The
court found the regulation invalid because the statutory grant of
authority provided by Congress did not “‘empower the Secretary to
regulate the scope of the judicial power vested by the statute.’”
Id. at 1170 (quoting Adams Fruit Co. v. Barrett, supra at 650).
Petitioner argues that the regulation is not entitled to any
judicial deference because under petitioner’s reading of the
statutory scheme, the Tax Court would have jurisdiction to
consider a partner’s reasonable cause defenses at the partnership
level but for the regulation. Petitioner points to changes made
to the TEFRA procedures in 1997 in support of its argument that
the Tax Court has jurisdiction to consider partner level
defenses. Before 1997, penalties were assessed at the partner
level. N.C.F. Energy Partners v. Commissioner, 89 T.C. at 744-
745. Congress, recognizing that penalties were often based upon
partnership-level conduct, enacted changes to section 6221.
These changes provide that penalties related to adjustments to
partnership items can be determined during the TEFRA proceeding.
If a partner who was unable to raise a defense disagreed with the
- 15 -
determination and subsequent assessment of those penalties,
Congress provided that partner with the opportunity to raise
partner-level defenses in a refund action. Sec. 6230(c)(4).
Petitioner argues that Congress intended to give partners
other than the general or managing partner a choice in deciding
where to raise their partner-level defenses; a partner can raise
them either during the TEFRA proceeding or in a later refund
action. Petitioner argues that because a partner is entitled to
choose when to raise those defenses but the regulation prevents
this choice, the regulation is invalid under Adams Fruit Co. v.
Barrett, supra, and Nagahi v. INS, supra.
Respondent argues that the 1997 amendments changed the
Court’s jurisdiction so that during the TEFRA proceeding
reasonable cause defenses can be raised, but they must be the
defenses of the partnership rather than those of individual
partners.
We agree with respondent that a partner cannot raise
partner-level defenses in a TEFRA proceeding. When considering
the determination of penalties at the partnership level, the
Court can consider the defenses of the partnership but not
partner-level defenses of individual partners. See Whitehouse
Hotel Ltd. Pship. v. Commissioner, 131 T.C. (2008); Santa
Monica Pictures, L.L.C. v. Commissioner, T.C. Memo. 2005-104;
Stobie Creek I; Jade Trading, L.L.C. v. United States, 80 Fed.
- 16 -
Cl. 11 (2007); cf. Klamath Strategic Inv. Fund, L.L.C. v. United
States, 472 F. Supp. 2d 885, 903-904 (E.D. Tex. 2007).
Before the 1997 amendments, the Court did not have
jurisdiction to consider the applicability of any penalties
during a partnership-level proceeding; therefore the Court did
not have jurisdiction to consider an individual partner’s
defenses. While those 1997 amendments expanded the Court’s
jurisdiction to consider penalties related to adjustments to
partnership items, nothing in section 6221 or 6226(f) granted the
Court jurisdiction over an individual partner’s partner-level
defenses. The 1997 amendments also added section 6230(c)(1)(C),
which provides that a partner may file a claim for refund on the
grounds that the Secretary erroneously imposed any penalty,
addition to tax, or additional amount that relates to an
adjustment to a partnership item, and the last two sentences of
section 6230(c)(4), which provide in relevant part that
notwithstanding that a determination under an FPAA or under a
decision of a court concerning the applicability of any penalty
related to a partnership item shall be otherwise conclusive, a
partner will be able to assert any partner-level defenses to the
penalty in a refund forum. These amendments make clear that a
partner may raise his partner level defenses only in a refund
action filed after the close of partnership-level proceedings.
The legislative history accompanying the Taxpayer Relief Act of
- 17 -
1997, Pub. L. 105-34, 111 Stat. 788, supports this view, stating:
“the partnership-level proceeding is to include a determination
of the applicability of penalties at the partnership level.
However, the provision allows partners to raise any partner-level
defenses in a refund forum.” H. Rept. 105-148, at 594 (1997),
1997-4 C.B. (Vol. 1) 319, 916.
The regulation at issue does not strip the Tax Court of
jurisdiction. The TEFRA structure enacted by Congress does not
permit a partner to raise partner-level defenses during a
partnership-level proceeding. See Jade Trading, L.L.C. v. United
States, supra. This reading of the statutory scheme is
consistent with Stobie Creek I, Stobie Creek II, AWG Leasing
Trust v. United States, 101 AFTR 2d 2397, 2008-1 USTC par. 50,370
(N.D. Ohio 2008), and Jade Trading, L.L.C. v. United States,
supra. Stobie Creek I, Stobie Creek II, and Jade Trading, L.L.C.
involved transactions substantially similar to the ones at issue
in the instant case. In all three the court considered the
defenses of the partnership, presented through the general or
managing partner, but not partner-level defenses of the partners.
This result is also consistent with AWG Leasing Trust v. United
States, supra, a sale-leaseback case in which the court sustained
penalties at the partnership level but stated that individual
partners might each be able to prove a reasonable cause defense
in a subsequent partner-level refund action under section
- 18 -
301.6221-1(d), Proced. & Admin. Regs. AWG Leasing Trust v.
United States, supra at 2425, 2008-1 USTC par. 50,370, at 84,245.
Petitioner also argues that if we were to follow
respondent’s interpretation, the result would conflict with the
policy that taxpayers should be able to challenge alleged tax
deficiencies without having to pay and file for a refund. While
it is true that a partner cannot raise partner-level defenses
during a partnership-level proceeding initiated in the Tax Court,
that partner would not be able to raise partner-level defenses
during a partnership-level proceeding in either the Court of
Federal Claims or a District Court. See Stobie Creek II; Jade
Trading, L.L.C. v. United States, supra. Because the statutory
scheme provides that a partner may raise his partner-level
defenses only in a later refund action, the regulation is
entitled to deference by this Court.
IV. Statutory Conflicts
Petitioner argues that even if we hold that the Secretary
had authority to issue section 301.6221-1T(c) and (d), Temporary
Proced. & Admin. Regs., supra, we must hold it invalid because it
is an unreasonable interpretation of the statutory scheme that
conflicts with sections 6221, 6230(c)(4), 6662, and 6664.
Section 6664(c)(1) provides that no penalty shall be imposed
under section 6662 or 6663 if it is shown that there was
reasonable cause. Petitioner argues that the regulation at issue
- 19 -
is invalid because it requires the Court to determine penalties
without evaluating reasonable cause defenses. Because section
301.6221-1T(c) and (d), Temporary Proced. & Admin. Regs., supra,
prohibits partners from raising partner-level defenses in a
partnership proceeding, petitioner argues that respondent’s
interpretation of the statutory scheme is incorrect because it
allows for the imposition of penalties on partners who cannot
raise partner-level defenses to those penalties except in a later
refund action. Petitioner argues that to impose penalties under
section 6662 on partners without considering those partners’
partner-level reasonable cause defenses under section 6664 as
required by the regulation violates the statutory scheme;
therefore the regulation is invalid. As discussed above,
petitioner argues that the current statutory scheme and the
legislative history, when read together, show that Congress
intended to offer partners the option to choose between raising
their partner-level defenses at the partnership level or
afterwards in a refund action.
It is important to note, however, that if a partner has a
partner-level individual reasonable cause defense to penalties
that is distinct from the partnership’s reasonable cause
defenses, that partner will be able to raise those defenses in a
refund forum. Sec. 6230(c)(4).
- 20 -
We need not revisit the controversy in this Court regarding
the proper standard of review of the Secretary’s regulations as
between the standard of Natl. Muffler Dealers Association, Inc.
v. United States, 440 U.S. 472 (1979), and the standard set forth
in Chevron U.S.A. Inc. v. Natural Res. Def. Council, Inc., 467
U.S. 837, 842-843 (1984). See Swallows Holding, Ltd. v.
Commissioner, 515 F.3d 162 (3d Cir. 2008), vacating 126 T.C. 96
(2006). Because petitioner states in its petition that New
Millennium had no principal place of business when the petition
was filed, barring stipulation to the contrary the venue for
appeal would appear to be the Court of Appeals for the District
of Columbia Circuit. See sec. 7482(b)(1) (flush language) and
(2). According to Golsen v. Commissioner, 54 T.C. 742 (1970),
affd. 445 F.2d 985 (10th Cir. 1971), we apply the law of the
Court of Appeals to which an appeal in the case would normally
lie. The U.S. Court of Appeals for the District of Columbia
Circuit has held that regulations issued under the general
authority of the IRS to promulgate necessary rules are entitled
to Chevron deference. See Tax Analysts v. IRS, 350 F.3d 100, 103
(D.C. Cir. 2003). Accordingly, we will follow the Chevron
standard in this analysis. The Supreme Court described the
analysis to be followed:
When a court reviews an agency’s construction of the statute
which it administers, it is confronted with two questions.
First, always, is the question whether Congress has directly
spoken to the precise question at issue. If the intent of
- 21 -
Congress is clear, that is the end of the matter; for the
court, as well as the agency, must give effect to the
unambiguously expressed intent of Congress. If, however,
the court determines that Congress has not directly
addressed the precise question at issue, the court does not
simply impose its own construction on the statute, as would
be necessary in the absence of an administrative
interpretation. Rather, if the statute is silent or
ambiguous with respect to the specific issue, the question
for the court is whether the agency’s answer is based on a
permissible construction of the statute.
Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., supra
at 842-843 (footnote references omitted).
We will take each paragraph of the regulation in turn. In
reviewing section 301.6221-1T(c), Temporary Proced. & Admin.
Regs., supra, we first turn to the text of the statute to
determine whether the intent of Congress is clear. In answering
this question, we are instructed not to confine our examination
to a particular statutory provision in isolation. Square D Co. &
Subs. v. Commissioner, 118 T.C. 299, 308 (2002) (citing FDA v.
Brown & Williamson Tobacco Corp., 529 U.S. 120, 133 (2000)),
affd. 438 F.3d 739 (7th Cir. 2006). The meaning, or ambiguity,
of certain words or phrases may become evident only when placed
in context. FDA v. Brown & Williamson Tobacco Corp., supra at
132-133 (citing Brown v. Gardner, 513 U.S. 115, 118 (1994)). It
is a “‘fundamental canon of statutory construction that the words
of a statute must be read in their context and with a view to
- 22 -
their place in the overall statutory scheme.’” Id. at 133
(quoting Davis v. Mich. Dept. of Treasury, 489 U.S. 803, 809
(1989)).
As discussed above, we believe that sections 6221,
6230(c)(1), and 6230(c)(4), when read in conjunction, make clear
that Congress intended for partners to raise partner-level
defenses during a refund action after the partnership proceeding.
Because we hold that Congress has directly spoken to the issue in
section 301.6221-1T(c), Temporary Proced. & Admin. Regs., supra,
we find paragraph (c) of that section to be a valid
interpretation of the TEFRA statutory scheme.
Next, we review section 301.6221-1T(d), Temporary Proced. &
Admin. Regs., supra. Under the first step of Chevron analysis,
we must determine whether Congress’s intent is clear. Section
6221 does not mention partner-level defenses. Partner-level
defenses, however, are mentioned in section 6230(c)(4). Because
we find that Congress has not spoken directly on the issue of
what constitutes a partner-level defense under section
6230(c)(4), we must determine whether the Secretary’s answer is
based on a permissible construction of the statute.
The first sentence of paragraph (d) of section 301.6221-1T,
Temporary Proced. & Admin. Regs., supra, simply restates that
partner-level defenses can be asserted only in a refund action.
The second sentence defines partner-level defenses as “those that
- 23 -
are personal to the partner or are dependant upon the partner’s
separate return, and cannot be determined at the partnership
level.” Id. The final sentence of paragraph (d) provides
examples of partner level defenses, including whether any
applicable threshold underpayment of tax has been met, whether
the criteria of section 6664(b) have been met, or whether
reasonable cause under section 6664(c) exists.
We believe that this is also a valid interpretation of the
statutory scheme. Congress, as discussed above, intended to have
partners raise partner-level defense to the imposition of
penalties during a refund action. The expansive definition
provided in 301.6221-1T(d) Temporary Proced. & Admin. Regs.,
supra, does not limit a partner’s defenses other than to confirm
that a partner-level defense is one that is personal to the
partner.
V. Whether Section 301.6221-1T(c) and (d), Temporary Proced. &
Admin. Regs. Applies
Lastly, petitioner argues that, even if we hold section
301.6221-1T(c) and (d), Temporary Proced. & Admin. Regs., supra,
to be valid, we should not apply it to the instant case.
Petitioner advances two arguments as to why the regulation at
issue should not apply: (1) Mr. Filipowski’s and AJF-1’s
partner-level defenses must be considered before determining
penalties against petitioner; and (2) because partner-level
- 24 -
conduct led to the imposition of penalties, partner-level
defenses must be considered.
Petitioner argues that although AJF-1 was not the general or
managing partner of New Millennium, AJF-1 was the majority 70-
percent partner who has brought suit to challenge respondent’s
FPAA. Petitioner’s argument is that any penalties determined
during this partnership-level proceeding will be based on partner
conduct; therefore, we should consider those partners’ defenses
when determining the applicability of any penalties. Petitioner
draws support for this argument from an IRS issue paper, which
states in pertinent part:
Good faith and reasonable cause of individual investors
pursuant to IRC § 6664 would be the type of partner level
defense that can be raised in a subsequent partner-level
refund suit. However, to the extent that the taxpayer
effectively acted as the general partner and that the intent
of the general partner is determined at the partnership
level, it is likely that such partnership level
determinations may also dispose of partner-level defenses
under the unique facts of each case.
Internal Revenue Service (I.R.S.) Industry Specialization Program
Coordinated Issue All Industries, Notional Principal Contracts,
UIL. No: 9300.20-00 (Jan. 6, 2005).
Petitioner also relies on Santa Monica Pictures, L.L.C. v.
Commissioner, T.C. Memo. 2005-104, and Long Term Capital Holdings
v. United States, 330 F. Supp. 2d 122 (D. Conn. 2004), affd. 150
Fed. Appx. 40 (2d Cir. 2005), for the proposition that a
partner’s defenses can be raised at the partnership proceeding.
- 25 -
Respondent points out, however, that in both Santa Monica
Pictures, L.L.C. and Long Term Capital Holdings, the defenses
considered were those of the managing partner, not a limited
partner such as AJF-1.
The applicability of section 301.6221-1T(c) and (d),
Temporary Proced. & Admin. Regs., supra, was also considered
recently in Jade Trading, L.L.C. v. United States, 80 Fed. Cl. 11
(2007), Stobie Creek I, Stobie Creek II, and Klamath Strategic
Inv. Fund, L.L.C. v. United States, 472 F. Supp. 2d 885 (E.D.
Tex. 2007). Those cases all concerned transactions substantially
similar to the one at issue. In Jade Trading, L.L.C., supra,
Stobie Creek I, and Stobie Creek II, partners were not allowed
to raise partner-level defenses during the partnership
proceeding. In Klamath Strategic Inv. Fund, L.L.C. v. United
States, supra at 903, the court applied the regulation but found
that under some circumstances the reasonable cause exception may
be considered a partnership-level defense. Section 301.6221-
1T(c) and (d), Temporary Proced. & Admin. Regs., supra, applies
to the instant case. It is clear from the legislative history
and the definitions in section 6231(a) that Congress did not wish
the Court to decide all issues associated with a partnership in a
single proceeding even if it has the information available to do
so. AJF-1, although a 70-percent partner in New Millennium, will
not be able to raise partner-level defenses during this
- 26 -
partnership proceeding. See Stobie Creek I; Jade Trading,
L.L.C., v. United States, supra. Any partnership defenses of New
Millennium will be considered when we determine whether any
penalties should be imposed after a trial on the merits.
Conclusion
Because we hold that the statutory scheme does not allow
partners to raise partner-level defenses to the determination
that penalties apply to adjustments to partnership items during a
partnership-level proceeding, we hold that the interpretation in
section 301.6221-1T(c) and (d), Temporary Proced. & Admin. Regs.,
supra, is a proper interpretation of the statutory scheme and is
therefore valid.
To reflect the foregoing,
An appropriate order
denying petitioner’s motion
will be issued.
- 27 -
APPENDIX
EXHIBIT A to the FPAA issued to petitioner made the
following determinations.
1. It is determined that neither New Millennium Trading,
L.L.C. nor its purported partners have established the
existence of New Millennium Trading, L.L.C. as a
partnership as a matter of fact.
2. Even if New Millennium Trading, L.L.C. existed as a
partnership, the purported partnership was formed and
availed of solely for purposes of tax avoidance by
artificially overstating basis in the partnership
interests of its purported partners. The formation of
New Millennium Trading, L.L.C., the acquisition of any
interest in the purported partnership by the purported
partner, the purchase of offsetting options, the
transfer of offsetting options to a partnership in
return for a partnership interest, the purchase of
assets by the partnership, and the distribution of
those assets to the purported partners in complete
liquidation of the partnership interests, and the
subsequent sale of those assets to generate a loss, had
no business purpose other than tax avoidance, lacked
economic substance, and, in fact and substance,
constitutes an economic sham for federal income tax
purposes. Accordingly, the partnership and the
transactions described above shall be disregarded in
full and any purported losses resulting from these
transactions are not allowable as deductions for
federal income tax purposes.
3. It is determined that New Millennium Trading, L.L.C.
was a sham, lacked economic substance and, under §
1.701-2 of the Income Tax Regulations, was formed and
availed of in connection with a transaction or
transactions in taxable year 1999, a principal purpose
of which was to reduce substantially the present value
of its partners’ aggregate federal tax liability in a
manner that is inconsistent with the intent of
Subchapter K of the Internal Revenue Code. It is
consequently determined that:
a. the New Millennium Trading, L.L.C. is disregarded
and that all transactions engaged in by the
purported
- 28 -
partnership are treated as engaged in directly by
its purported partners. This includes the
determination that the assets purportedly acquired
by New Millennium Trading, L.L.C., including but
not limited to foreign currency options, were
acquired directly by the purported partners.
b. the foreign currency option(s), purportedly
contributed to or assumed by New Millennium
Trading, L.L.C., are treated as never having been
contributed to or assumed by said partnership and
any gains or losses purportedly realized by New
Millennium Trading, L.L.C. on the option(s) are
treated as having been realized by its partners.
c. the purported partners of New Millennium Trading,
L.L.C. should be treated as not being partners in
New Millennium Trading, L.L.C..
d. contributions to New Millennium Trading, L.L.C.
will be adjusted to reflect clearly the
partnership’s or purported partners’ income.
4. It is determined that neither New Millennium Trading,
L.L.C. nor its purported partners entered into the
option(s) positions or purchase [sic] the foreign
currency or stock with a profit motive for purposes of
§ 165(c)(2).
5. It is determined that, even if the foreign currency
option(s) are treated as having been contributed to New
Millennium Trading, L.L.C., the amount treated as
contributed by the partners under section 722 of the
Internal Revenue Code is reduced by the amounts
received by the contributing partners from the
contemporaneous sales of the call option(s) to the same
counter-party. Thus, the basis of the contributed
option(s) is reduced, both in the hands of the
contributing partners and New Millennium Trading,
L.L.C.. Consequently, any corresponding claimed
increases in the outside basis in New Millennium
Trading, L.L.C. resulting from the contributions of
foreign currency option(s) are disallowed.
6. It is determined that the adjusted bases of the long
call positions (purchased call options), zero coupon
notes, and other contributions purportedly contributed
by the partners to New Millennium Trading, L.L.C. has
- 29 -
not been established under I.R.C. § 723. It is
consequently determined that the partners of New
Millennium Trading, L.L.C. have not established
adjusted bases in their respective partnership
interests in an amount greater than zero (-0-).
7. It is further determined that, in the case of a sale,
exchange, or liquidation of New Millennium Trading,
L.L.C. partners’ partnership interests, neither the
purported partnership nor its purported partners have
established that the bases of the partners’ partnership
interests were greater than zero for purposes of
determining gain or loss to such partners from the
sale, exchange, or liquidation of such partnership
interest.
8. Accuracy-Related Penalties
It is determined that the adjustments of partnership
items of New Millennium Trading, L.L.C. are
attributable to a tax shelter for which no substantial
authority has been established for the position taken,
and for which there was no showing of reasonable belief
by the partnership or its partners that the position
taken was more likely than not the correct treatment of
the tax shelter and related transactions. In addition,
all of the underpayments of tax resulting from those
adjustments of partnership items are attributable to,
at a minimum, (1) substantial understatements of income
tax, (2) gross valuation misstatement(s), or (3)
negligence or disregarded rules or regulations. There
has not been a showing by the partnership or any of its
partners that there was a reasonable cause for any of
the resulting underpayments, that the partnership or
any of its partners acted in good faith, or that any
other exceptions to the penalty apply. It is therefore
determined that, at a minimum, the accuracy-related
penalty under Section 6662(a) of the Internal Revenue
Code applies to all underpayments of tax attributable
to adjustments of partnership items of New Millennium
Trading, L.L.C.. The penalty shall be imposed on the
components of underpayment as follows:
A. a 40 percent penalty shall be imposed on the
portion of any underpayment attributable to the
gross valuation misstatement as provided by
Sections 6662(a), 6662(b)(3), 6662(e), and 6662(h)
of the Internal Revenue Code.
- 30 -
B. a 20 percent penalty shall be imposed on the
portion of the underpayment attributable to
negligence or disregard of rules and regulations
as provided by Sections 6662(a), 6662(b)(1),
6662(c) of the Internal Revenue Code.
C. a 20 percent penalty shall be imposed on the
underpayment attributable to the substantial
understatement of income tax as provided by
sections 6662(a), 6662(b)(2), and 6662(d) of
the Internal Revenue Code.
D. a 20 percent penalty shall be imposed on the
underpayment attributable to the substantial
valuation misstatement as provided by Sections
6662(a), 6662(b)(3), and 6662(e) of the Internal
Revenue Code.
It should not be inferred by the determination of the
Accuracy Related Penalty in this notice that fraud
penalties will not be sought on any portion of an
underpayment subsequently determined to be attributable
to fraud or that prosecution for criminal offenses will
not be sought under IRC §§ 7201, 7206 or other
provisions of federal law if determined to be
appropriate.