IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT United States Court of Appeals
Fifth Circuit
FILED
April 3, 2009
No. 07-31163 Charles R. Fulbruge III
Clerk
In The Matter Of: ELVIN L MARTINEZ
Debtor
---------------------------------------------------------------------
UNITED STATES OF AMERICA
Appellee-Cross-Appellant
v.
ELVIN L MARTINEZ
Appellant-Cross-Appellee
Appeal from the United States United States District Court
for the Eastern District of Louisiana
Before REAVLEY, BARKSDALE, and GARZA, Circuit Judges.
REAVLEY, Circuit Judge:
This appeal presents questions of a limitation bar to income tax
adjustments for limited partnerships and the effectiveness of extensions
executed by the tax matters partner. Debtor Elvin L. Martinez seeks to avoid
tax liabilities associated with various partnerships for the years 1987 through
1993, which he contends were discharged in his personal bankruptcy because the
Internal Revenue Service (IRS) failed to assess the taxes within the three-year
No. 07-31163
limitations period for doing so. The issue on appeal is whether the limitations
period was tolled by actions of the tax matters partner, Walter J. Hoyt, III. The
bankruptcy court determined that for the years 1990 to 1993 Hoyt’s challenge
to the taxes in the tax court precluded the IRS from assessing any tax until
completion of those proceedings, and therefore the later assessments for those
years were not filed outside the limitations period, and Martinez’s liabilities
were not discharged. For the years 1987 to 1989, however, the court determined
that Hoyt’s consents on behalf of the partnership to extend the limitations period
were invalid because Hoyt had a disabling conflict of interest of which the IRS
was aware, and therefore Martinez’s tax liabilities were discharged in
bankruptcy. Martinez and the Government cross appeal from the district court’s
order affirming the bankruptcy court. We AFFIRM the district court’s judgment
with respect to the years 1990 to 1993, but we REVERSE with respect to the
years 1987 to 1989.
I.
Beginning in the 1970s Walter J. Hoyt, III, formed scores of limited
partnerships, ostensibly to engage in the business of breeding cattle and sheep.
Although the partnerships owned real livestock, they actually served as abusive
tax shelters from which individual tax savings could be achieved through
partnership deductions and losses. Hoyt promoted the partnerships to investors
around the country, much to his personal gain.
The partnership interests consisted of “units” purchased by investors with
cash and promissory notes. The partners also used notes to buy the cattle from
Hoyt’s family-run cattle operation, which then acted as manager of the herds.
The cattle purportedly would produce calves, which could be sold to cover the
partnership costs. The herds would also increase in size through the purchase
of additional mature cattle. Partnership losses and credits would be passed
through to the individual partners to reduce their personal tax liabilities to zero
2
No. 07-31163
and to obtain tax refunds. The refunds were used to cover the cost of the
investors’ investment and to make payments on the promissory notes. Hoyt was
the general partner and prepared all of the tax returns for both the partnerships
and most of the individual partners through his tax preparation firm.
Since 1980, the IRS and other government agencies had been investigating
Hoyt’s partnerships because of the suspicion that Hoyt routinely overvalued the
cattle in order to achieve excessive depreciation, overstated the number of cattle
in existence, and commingled the herd among the different partnerships. In
1989 the IRS unsuccessfully challenged Hoyt’s partnerships in Bales v.
Commissioner,1 where the tax court held that the partnerships were not shams
and that the individual partners were entitled to claim their allowable share of
partnership losses. The IRS conducted criminal investigations of Hoyt from
April 1984 to August 1987, and from July 1989 to October 1990. In each case the
Government decided not to prosecute Hoyt. Hoyt was also investigated from
August 1993 to October 1993 and again in September 1995, but each
investigation ended without a prosecution. The Government was unable to
prevail against Hoyt until 2001, when he was convicted of conspiracy, mail
fraud, bankruptcy fraud, and money laundering in connection with partnership
activities.
Debtor Martinez became an investor and partner with Hoyt in 1985 and
remained involved in four partnerships until 1994. Hoyt was the designated tax
matters partner for all of the partnerships and acted accordingly as liaison with
the IRS in administrative and litigation proceedings on tax matters concerning
the partnerships.2 Beginning in 1988, the IRS sent numerous notices to
Martinez about its concerns with Hoyt’s activities and the claimed deductions
1
58 T.C.M. (CCH) 431, 1989 WL 123005 (1989).
2
See 26 U.S.C. § 6231(a)(7); 26 C.F.R. § 301.6231(a)(7)-1.
3
No. 07-31163
and losses on partnerships returns. The notices stated the IRS’s belief that
purported tax shelter deductions and/or credits were not allowable and that, if
claimed, the IRS planned to disallow them. The notices also informed Martinez
that the Internal Revenue Code provided for penalties against partners for
negligence, overvaluation, and understatement of income on partnership
returns, and that if Hoyt claimed the deductions and credits Martinez might
wish to seek an adjustment himself. The IRS also sent several notices in 1992
informing Martinez of problems with claimed deductions for passive losses that
Hoyt advocated, and it suggested that Martinez might wish to file an amended
personal return or consult with an accountant or attorney. Martinez did not
respond to the IRS’s notices and instead forwarded them to Hoyt.
Generally, when the IRS disagrees with a partnership’s claim on a return
it has three years in which to audit the return and issue a deficiency notice,
known as a Notice of Final Partnership Administrative Adjustment.3 The period
for the tax assessment is then extended for one year after the adjustment.4 In
the instant case, the IRS disagreed with Hoyt’s partnership returns for the tax
years 1987 to 1989 but was unable to issue timely adjustments. Hoyt, acting as
the tax matters partner, granted the IRS extensions of the three-year limitations
period, however. The validity of the subsequent adjustments hinges on the
validity of the extensions.
The extensions were signed from February 1991 to March 1993. Hoyt
granted the first extension of the limitations period for 1987 because an IRS
team was already conducting an audit for the years 1980–1986, and he wished
to delay the 1987 audit until the earlier examination was complete. In
December 1991 the IRS then asked Hoyt to agree to a second extension. It
3
See 26 U.S.C. § 6229(a).
4
See 26 U.S.C. § 6229(a) & (d).
4
No. 07-31163
believed that without that extension it would have to close its audit and issue
adjustments with blanket disallowances of all claimed deductions, but it wished
to avoid that circumstance and wanted to obtain further documentation from
Hoyt.
At about the same time that it asked for the extension, the IRS also
informed Hoyt that it was considering assessing preparer penalties against him.
Hoyt responded that he would grant the extensions to issue the adjustments if
the IRS would agree to extend the limitations period for assessing the preparer
penalties. The IRS finally agreed as part of a settlement in other litigation
involving Hoyt’s partnerships occurring in federal court in Oregon, where the
IRS was seeking to conduct a physical headcount of the cattle. Hoyt agreed to
the extensions and gave the IRS until December 31, 1993, to issue the
adjustments for the 1987 to 1989 tax years. The IRS issued them before that
deadline.
For the tax years 1990 to 1993, the IRS did not need any extensions and
issued timely adjustments disagreeing with Hoyt’s partnership returns. Hoyt
challenged all of the adjustments from 1987 to 1993 by filing petitions in the tax
court contesting them. Those challenges were still being litigated at the time the
instant action was filed.
In August 2002 Martinez filed a Chapter 7 bankruptcy petition. The
bankruptcy court issued a discharge, and the case was closed. The IRS
subsequently sent notices of tax deficiency to Martinez for the years 1987
through 1993 in connection with improperly claimed deductions from his
membership in Hoyt’s partnerships. Martinez then reopened the bankruptcy
case in October 2003 to claim that all of his tax liabilities had been discharged.
Martinez’s theory was that Hoyt had acted under a disabling conflict of interest
when, as tax matters partner, Hoyt granted the IRS extensions of the limitations
period for the 1987 to 1989 tax years and when he challenged the IRS’s
5
No. 07-31163
adjustments in the tax court for the 1990 to 1993 tax years. He reasoned that
any taxes sought by the IRS were therefore no longer assessable and had been
discharged by the bankruptcy proceeding.
After a two-day trial, the bankruptcy court issued a decision separately
analyzing the two time periods. First, with respect to 1990 to 1993, the court
held that the IRS issued valid adjustments, which Hoyt then challenged by filing
timely tax court petitions. Once those petitions were entered on the tax court
docket, said the court, the IRS was statutorily precluded from assessing a tax
until the conclusion of the tax court proceedings, regardless of any alleged
conflict of interest. Because those proceedings were still pending, the court held
that the limitations period had been tolled and the tax liabilities for 1990 to 1993
were not discharged.
Second, with respect to 1987 to 1989, the bankruptcy court held that the
taxes were no longer assessable and were discharged because when Hoyt had
signed the extensions of the limitations period he had a disabling conflict of
interest and had breached his fiduciary duty to his partners as the tax matters
partner. The court found that internal IRS documents showed that Hoyt was
committing fraud and deceiving his partners through his control over all aspects
of the partnerships and tax documents. Hoyt’s activity included preparing
individual partner tax returns reflecting partnership losses when there were
problems with shortages of cattle inventory and overvaluation of cattle. The
court noted that the IRS was considering imposing return preparer penalties on
Hoyt in December 1991 at the same time that it asked Hoyt to sign the extension
of the limitations period for the 1987 to 1989 tax years. The court also found
that Hoyt attempted to extract a quid pro quo for his agreement to sign the
extensions because he conditioned the extensions on the IRS agreeing to extend
the limitations period for the assessment of preparer penalties. The court
referred to the transcript from the Oregon district court proceedings where Hoyt
6
No. 07-31163
consented to the extension after the IRS agreed to forbear assessing preparer
penalties until the adjustments issued. Finally, the court concluded that Hoyt
was attempting to stall the IRS investigations and the issuance of the
adjustments, and it noted that the IRS was concerned about issuing them
without obtaining extensions. The court concluded that a delay benefitted Hoyt
personally but was contrary to the interests of the partners. The court held that
Hoyt was not acting in the interests of his partners when dealing with the IRS,
and the extensions of the limitations period were therefore invalid because the
IRS knew of the conflict. Because the extensions were invalid, the court held
that the limitations period had run and the taxes for 1987 to 1989 were not
properly assessable after Martinez filed the bankruptcy petition and were
discharged.
Martinez and the Government cross appealed to the district court, which
affirmed the bankruptcy court’s decision. Both parties now cross appeal to this
court.
II.
We review a district court’s affirmance of a bankruptcy court decision by
applying the same standard of review to the bankruptcy court decision that the
district court applied. In re OCA, Inc.5 “We thus generally review factual
findings for clear error and conclusions of law de novo.”6
Ordinarily, a discharge in bankruptcy does not apply to certain specified
tax debts. 7 The bankruptcy court held, and we agree, that these non-
dischargeable tax debts include taxes that are still assessable after the
commencement of the bankruptcy petition, including those taxes for which a tax
5
551 F.3d 359, 366 (5th Cir. 2008).
6
Id.
7
See 11 U.S.C. § 523(a)(1)(A).
7
No. 07-31163
court case was pending at the time of the bankruptcy filing.8 The question
therefore is whether Martinez’s tax liabilities for all years at issue, 1987 to 1993,
were still assessable at the time he filed his bankruptcy petition in 2002. That
question requires reference to the tax laws governing partnerships.
The partnerships at issue are subject to the Tax Equity Fiscal
Responsibility Act of 1982 (TEFRA), which prescribes the administrative and
litigation procedures for addressing partnership tax issues.9 Under TEFRA,
partnerships file informational returns showing partnership income, gains,
losses, deductions, and credits, while individual partners report their pro rata
share of tax on individual returns. Weiner v. United States.10 Items which are
more appropriately determined at the partnership level than at the individual
partner level are treated as “partnership items” for tax treatment at the
partnership level, and all other items are treated as nonpartnership items.11
While dealing with partnership items, the IRS generally consults with the
partnership’s tax manager, who is typically designated by the partners and has
the authority in most instances to bind the partnership.12 When proposing
adjustments to taxes at the partnership level as a result of an audit, the IRS
8
See 11 U.S.C. § 507(a)(8); Matter of Johnson, 146 F.3d 252, 256–57 & n.9 (5th Cir.
1998). Section 523(a)(1)(A) of the bankruptcy code excludes from discharge taxes specified in
§ 507(a)(8), which includes “allowed unsecured claims of governmental units, only to the extent
that such claims are for . . . (A) a tax on or measured by income or gross receipts . . . (iii) other
than a tax . . . not assessed before, but assessable, under applicable law or by agreement, after,
the commencement of the case.”
9
See Pub. L. No. 97-248, §402(a), 96 Stat. 648, 653 (1982) (codified as amended at 26
U.S.C. §§ 6221–23).
10
389 F.3d 152, 154 (5th Cir. 2004).
11
Id.; see also 26 U.S.C. §§ 6221, 6231(a)(3) & (a)(4).
12
See 26 U.S.C. § 6224(c)(3). The tax matters partner is generally defined as “the
general partner designated as the tax matters partner as provided in regulations” or, if no
general partner has been so designated, as “the general partner having the largest profits
interest in the partnership at the close of the taxable year involved.” 26 U.S.C. § 6231(a)(7).
8
No. 07-31163
issues a notice of adjustment, which is the equivalent of a statutory notice of
deficiency given to an individual.13 The IRS has three years from the later of (1)
the date the partnership return is filed or (2) the date that the partnership
return is due, to issue an adjustment for a given tax year.14 This three-year
period may be extended, however, by agreement between the IRS and the tax
matters partner.15
After the IRS issues an adjustment, the tax matters partner has 90 days
to seek a readjustment by filing a petition in the tax court, the Court of Federal
Claims, or a United States district court.16 When a petition is filed in tax court,
the limitations period for assessing a tax is suspended until the decision of the
tax court becomes final and for one year thereafter.17
III.
With these background principles in mind, we address first Martinez’s
appeal before turning to the Government’s cross appeal. Martinez appeals the
13
26 U.S.C. § 6223(a); see PAA Mgmt., Ltd. v. United States, 962 F.2d 212, 214 (2d Cir.
1992).
14
26 U.S.C. § 6229(a). The statute provides:
General rule.--Except as otherwise provided in this section, the period for
assessing any tax imposed by subtitle A with respect to any person which is
attributable to any partnership item (or affected item) for a partnership taxable
year shall not expire before the date which is 3 years after the later of--
(1) the date on which the partnership return for such taxable year was filed, or
(2) the last day for filing such return for such year (determined without regard
to extensions).
Id.
15
26 U.S.C. § 6229(b).
16
26 U.S.C. § 6226(a).
17
26 U.S.C. § 6229(d).
9
No. 07-31163
district court’s decision to affirm the bankruptcy court concerning the tax years
1990 to 1993. He contends that although Hoyt filed tax court petitions
challenging the IRS’s adjustments for 1990 to 1993, Hoyt had a serious conflict
of interest with his partners that barred him from acting on behalf of the
partnership. He reasons that the 1990 to 1993 petitions were therefore invalid
and did not toll the limitations period for assessing taxes for those years.
Because the limitations period had run by the time he filed his bankruptcy
petition, Martinez contends that his tax liability for those years was discharged.
We have little trouble disposing of this part of the case.
As noted above, the three-year statute of limitations for assessing a tax
attributable to partnership items is suspended when a tax court petition is
filed.18 What is more, once a tax court proceeding has begun the IRS is expressly
prohibited by statute from assessing a tax until the decision of the tax court
becomes final.19 This statutory scheme provides no room for Martinez’s
argument, as he does not contest that the IRS issued timely adjustments or that
Hoyt filed timely challenges in the tax court. Once Hoyt invoked the tax court
process to contest the adjustments, the limitation period was suspended until
18
Id.
19
26 U.S.C. § 6225(a). The statute provides in relevant part:
Restriction on assessment and collection.--Except as otherwise provided in this
subchapter, no assessment of a deficiency attributable to any partnership item
may be made (and no levy or proceeding in any court for the collection of any
such deficiency may be made, begun, or prosecuted) before--
(1) the close of the 150th day after the day on which a notice of a final
partnership administrative adjustment was mailed to the tax matters partner,
and
(2) if a proceeding is begun in the Tax Court under section 6226 during such
150-day period, the decision of the court in such proceeding has become final.
Id.
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No. 07-31163
that process was concluded, regardless of the validity of Hoyt’s status as tax
matters partner or the existence of any deficiency in the petitions. We are not
the first court to so hold.
The Ninth Circuit has similarly held that a tax assessment was not barred
by the limitations period where a tax matters partner filed a tax petition on
behalf of a partnership at the time that his status was a legal nullity due to his
previously filing a personal bankruptcy petition. O’Neill v. United States.20
Although the tax court later dismissed the petition for lack of jurisdiction, the
Ninth Circuit held that the petition “served to suspend the limitation period
because there was an existing unresolved matter before the Tax Court.” 21 The
Ninth Circuit followed the reasoning of a Second Circuit case that addressed a
predecessor tax provision and concluded that a petition placed on the docket of
the Board of Tax Appeals suspended the limitations period even though the
petition was later determined to have a jurisdictional defect. See Am. Equitable
Assurance Co. v. Helvering.22
Although Martinez argues that O’Neill and American Equitable are
distinguishable because they did not involve a tax manager’s alleged conflict of
interest, their reasoning is applicable. Whether a tax matters partner actually
has a disabling conflict of interest when he files tax petitions would by necessity
be an issue addressable by the tax court when considering the petitions. But
because the IRS may not assess a tax while the tax court proceedings are
pending, see § 6225(a), under Martinez’s theory, the IRS could be barred from
assessing a properly owed tax merely if the tax court is fortuitously unable to
adjudicate the petition before the limitations period has run. We agree with the
20
44 F.3d 803, 805–06 (9th Cir. 1995).
21
Id. at 806.
22
68 F.2d 46, 47 (2d Cir. 1933).
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No. 07-31163
Ninth Circuit that “this is not what Congress intended.” 23 We therefore conclude
that the bankruptcy court and the district court properly determined that the
limitations period was tolled for the 1990 to 1993 tax years, and Martinez’s tax
liability for those years was therefore not discharged in the bankruptcy
proceeding.
IV.
We turn now to the Government’s cross appeal. The Government
challenges the determination below that Hoyt was acting under a disabling
conflict of interest that rendered invalid the extensions for the limitations period
on the 1987 to 1989 tax years. We have not previously addressed whether a
conflict between a tax matters partner and the remaining partners may disable
the tax manager’s actions with respect to the partnership and, if so, the
parameters of such a conflict. We agree with other circuits that have addressed
the matter and determine that there may be times when a tax matters partner’s
actions beneficial to himself are so contrary to the interests of the partnership
that they are rendered null with respect to the partners. But we hold that under
the circumstances present the court should not burden the IRS with a decision
so as to nullify actions taken with the tax matters partner.
It is settled law that a tax matters partner owes a fiduciary duty to his
partners.24 In light of this fiduciary duty, other circuits have held that when he
has a severe conflict of interest with his partners that is known to the IRS, he
23
O’Neill, 44 F.3d at 806. See also Martin v. Comm’r, 436 F.3d 1216, 1223–24 (10th
Cir. 2006) (addressing tolling under 26 U.S.C. § 6503, the analogous statute applicable to the
limitations period as applied to an individual taxpayer, and holding that “the placing of a
proceeding on the docket of the tax court, not the manner in which such a proceeding is
resolved, is key to tolling the running of the statute of limitations”).
24
See Phillips v. Comm’r, 272 F.3d 1172, 1175 (9th Cir. 2002); Transpac Drilling
Venture 1982-12 v. Comm’r, 147 F.3d 221, 225 (2d Cir. 1998); Computer Programs Lambda,
Ltd. v. Comm’r, 89 T.C. 198, 205 (1987).
12
No. 07-31163
may not bind the individual partners and the partnership by his dealings with
the Government.25
The tax matters partner “is the central figure of partnership proceedings”
and “serves as the focal point for service of all notices, documents and orders on
the partnership.” 26 He is required to keep the remaining partners informed of
administrative and judicial proceedings, and his actions may be binding on the
partnership.27 He serves as the representative of all partners vis á vis the IRS. 28
As explained by the tax court, “[t]he detailed statutory procedures for
partnership level audits and litigation contemplate the continual presence of one
tax matters partner, and the procedures cannot operate unless the tax matters
partner is capable of acting on the partnership’s behalf regardless of his personal
tax posture.”29 If the tax manager’s fiduciary duty to his partners is
compromised by a conflict with his own tax situation, his actions are properly
voided in order to protect those partner and partnership interests otherwise
served by him.30
25
See Phillips, 272 F.3d at 1175; Transpac Drilling, 147 F.3d at 227–28.
26
Lambda, 89 T.C. at 205.
27
Id.; see also 26 U.S.C. § 6229(b)(1)(B) (providing that the limitations period for
assessing a tax attributable to partnership items may be extended “with respect to all
partners, by an agreement entered into by the Secretary and the tax matters partner”).
28
See Transpac Drilling, 147 F.2d at 225 (“By centralizing tax-related proceedings of
the partnership in one person or entity, Congress created a statutory analogue of the class
representative in class action proceedings.”).
29
Lambda, 89 T.C. at 205.
30
See Phillips, 272 F.3d at 1175 (“Trust law, generally, invalidates the transaction of
a trustee who is breaching his trust in a transaction in which the other party is aware of the
breach.” (citing RESTATEMENT OF TRUSTS §§ 288–297)); Transpac Drilling, 147 F.3d at 225
(noting that “limited partners secure their due process protection as a result of the fact that
the TMP stands in a fiduciary relationship toward them”).
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No. 07-31163
We are unpersuaded by the Government’s contention that because
Treasury regulations governing the designation and removal of a tax matters
partner do not specify that a conflict of interest is a reason for removing him,
deference to the regulations makes it improper to hold that the IRS may not rely
on a conflicted tax manager’s grant of an extension of the limitations period.31
The Internal Revenue Code grants the Secretary authority to promulgate
regulations that serve the efficient administration of the tax laws.32 But the
absence of a specific regulation addressing conflicts of interest does not mean
that a tax matters partner’s actions may bind the partnership irrespective of a
conflict. We agree with the Second Circuit that “[t]he elimination of conflicts,
even if not addressed in the existing regulations, is surely an appropriate
concern to the effective and efficient administration of the tax laws.” 33 Thus,
“where serious conflicts exist, a [tax matters partner] may be barred from acting
on behalf of the partnership,” 34 and we may not ignore an egregious situation
and defer to the IRS the discretion to choose whether to rely on a tax matters
partner’s position that is known to be adverse to that of the partnership.
The Second Circuit was addressing such a conflict in Transpac Drilling.
The court there found that a disabling conflict of interest invalidated three tax
managers’ consents to extend the limitations period even though the IRS chose
not to exercise its regulatory authority to remove the tax matters partners. In
that case, the IRS was conducting civil audits of multiple partnerships as
illegitimate tax shelters at the same time that there were ongoing criminal
31
See Treas. Reg. § 301.6231(a)(7)-1 (providing for designation and termination of a tax
matters partner).
32
See Transpac Drilling, 147 F.3d at 227; see also 26 U.S.C. § 6231(c) (authorizing the
Secretary to determine areas of “special enforcement consideration[].”
33
Transpac Drilling, 147 F.3d at 228 n.9.
34
Id. at 227.
14
No. 07-31163
investigations of the partnerships’ promoter and three tax matters partners.35
The IRS initially sought extensions of the statute of limitations for the civil
audits from the limited partners, who refused to grant the extensions.36 The IRS
then requested the extensions from the tax managers, who knew that they were
being investigated and who were also cooperating with the Government in its
case against the promoter.37 The tax managers granted the extensions. The
Second Circuit held that the extensions were invalid because the criminal
investigations gave the tax matters partners “powerful incentive to ingratiate
themselves to the government” and created “overwhelming pressure . . . to ignore
their fiduciary duties to the limited partners.” 38 The court found “especially
disquieting” the fact that the IRS knew the limited partners did not want to
grant extensions before it asked the tax managers to give it what the partners
had already denied.39
The Second Circuit subsequently clarified that its holding in Transpac
Drilling was based on the presence of a clear and actual conflict. Madison
Recycling Assocs. v. Comm’r.40 In Madison Recycling, the court found no
disabling conflict of interest where there was no evidence that the tax matters
partner had incentive to ingratiate himself to the IRS, either because he was a
prospective witness seeking immunity or was a known target of a criminal
investigation.41 The court concluded that unless the tax matters partner was
35
Id. at 223–24.
36
Id. at 224.
37
Id. at 223–24.
38
Id. at 227.
39
Id.
40
295 F.3d 280, 288 (2d Cir. 2002).
41
Id. at 289.
15
No. 07-31163
aware of the existence or prospect of a criminal investigation, it could not see
how his personal concerns could have influenced him and prevented the proper
discharge of his fiduciary duties to the limited partners.42 Thus, a disabling
conflict of interest will be shown only when the tax matters partner has cause
to prefer his own interests above his fiduciary duties, and the IRS knows that his
actions are more than likely contrary to the wishes and interests of the limited
partners.
In the instant case, we find that the circumstances do not support a
similar finding that Hoyt acted under a disabling conflict when he granted the
extensions to the IRS. Unlike Transpac Drilling, where the “facts of the matter
[spoke] for themselves,” here the same sort of overwhelming circumstances and
knowledge by the IRS that made inescapable a finding of a conflict are absent.43
There is no indication that the IRS attempted to obtain extensions from the
partners before turning to Hoyt, or that the partners were opposed to the
extensions. Hoyt was also not under criminal investigation at the time that he
executed the extensions of the limitations period. Although he had been under
criminal investigation earlier, that fact alone does not create a disabling
conflict.44 Moreover, there is no indication that when he granted the extensions
Hoyt feared another criminal investigation, and there is no evidence of Hoyt’s
thought process that would indicate a desire to “ingratiate [himself] to the
government.” 45
42
Id.
43
See Transpac Drilling, 147 F.3d at 227 (“That the TMPs’ interests and those of the
ones who would be bound by their actions were in severe conflict cannot be doubted.”).
44
See River City Ranches # 1 Ltd. v. Comm’r, 401 F.3d 1136, 1142 (9th Cir. 2005) (River
City Ranches II); Phillips, 272 F.3d at 1174.
45
Transpac Drilling, 147 F.3d at 227.
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No. 07-31163
The bankruptcy court held that Hoyt was operating under a disabling
conflict of interest for three reasons. It inferred from each that Hoyt was not
acting in the interests of his partners when dealing with the IRS and that the
IRS knew this fact. First, the court found that Hoyt was defrauding his
partners. The court cited internal IRS memoranda detailing Hoyt’s fraudulent
accounting practices, including the overvaluation of cattle and over counting of
the livestock. The documentation does show that the IRS viewed Hoyt’s
partnerships and accounting practices as mere shams to perpetuate his cattle
operations and fraudulently avoid taxes. Many of the documents cited by the
court, however, predated or were close in time to the tax court’s decision in
Bales. In that case, the IRS challenged, inter alia, Hoyt’s depreciation methods
and his valuation of cattle, as well as the partners’ ability to claim deductions for
partnership losses on their returns.46 The tax court rejected the IRS’s position
and concluded that the cattle partnerships were profit-seeking businesses rather
than economic shams and that the partners were permitted their allowable
share of partnership items and losses.47 Although Hoyt may ultimately have
defrauded his partners and the IRS in connection with the partnerships, at the
time that the IRS was seeking the extensions in this case, it had already been
rebuffed in its effort to prove this fact. Testimony at trial revealed that the IRS
believed the Bales case had partly legitimized Hoyt’s operations and affected
how it viewed the case. Although it believed the partnerships were shams, the
IRS also believed as a direct result of Bales that it had to obtain much stronger
evidence to perform a successful audit. It is therefore not obvious that the IRS
should have known at the time of the extensions that Hoyt had a disabling
conflict with respect to the partnerships at issue in this case.
46
See Bales, 1989 WL 123005, at *1.
47
Id. at *27–29.
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No. 07-31163
The bankruptcy court noted that on December 12, 1991, the IRS notified
Hoyt that it was considering imposing return preparer penalties for willful or
reckless conduct. This notice to Hoyt concerned returns for the 1989 and 1990
tax years and was almost two years after the Bales decision. It is not clear,
however, that the potential for assessment of preparer penalties on Hoyt tainted
Hoyt’s grant of an extension of the limitations period. We do not think the mere
risk of preparer penalties in this case, unlike say an indictment, provided the
kind of “powerful incentive” for Hoyt to act contrary to his partners’ interest. We
do not hold that a threat of penalties may never cause a conflict between a TMP
and his partners. But here Hoyt had been battling the IRS for over a decade and
had previously prevailed in Bales. It is therefore not apparent that the IRS
viewed its threat of penalties, apart from a criminal investigation, as causing
overwhelming pressure for Hoyt to ignore his fiduciary duties.
The bankruptcy court’s second basis for finding a disabling conflict was
that Hoyt attempted to extract a quid pro quo from the IRS in connection with
the preparer penalties. Hoyt agreed to extensions of the limitations period for
the 1987 to 1989 tax years in February 1991, July 1992, and March 1993. The
extension that was eventually granted in July 1992 originated with the IRS’s
request in December 1991, at the same time that the IRS had threatened to
impose the preparer penalties for 1989 and 1990. Hoyt said he would not agree
to an extension unless the IRS agreed to extend the limitations period for
assessing preparer penalties against him and other preparers who worked for
him, including his brother-in-law Henry Nathaniel. On its face, this request
made little sense because, if granted, it would merely give the IRS more time to
assess penalties against Hoyt. Nevertheless, the IRS refused to connect an
extension of the limitations period for issuing the adjustments for 1987 to 1989
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No. 07-31163
with an extension on the time for assessing preparer penalties.48 Subsequently,
however, in June 1992 the IRS agreed to forbear assessing penalties until the
time for issuing the adjustments, and Hoyt signed the extensions in July 1992.
We find this purported quid pro quo insufficient to substantiate a conflict
under the facts of this case. IRS revenue agent Norm Johnson testified that at
the time the IRS agreed to Hoyt’s request it had already determined that it
would not seek preparer penalties against Hoyt. Agent Johnson testified that
it therefore did not matter to the IRS whether to extend the preparer penalties
because it believed they were not worth pursuing. He also explained that in July
1992 the IRS could not have assessed preparer penalties against Hoyt because
the audits upon which the penalties would have been based were incomplete.
In other words, under the normal process for assessing preparer penalties it
would be premature to seek penalties before the audits were sufficiently
complete to know that penalties were appropriate. In order for there to be a true
quid pro quo, the parties must each exchange valuable concessions. See United
States v. Robinson.49 There must be a mutuality of advantage and a mutuality
of disadvantage.50 That did not exist here because the IRS essentially gave up
nothing, and Hoyt obtained nothing of true value.
The bankruptcy court correctly noted that Hoyt apparently believed he
was receiving something of value, but Hoyt’s perception does not necessarily
mean that he was acting in conflict with his partners. Agent Johnson testified
that although the partnerships derived no benefit from delaying preparer
penalties against Hoyt, there was also no harm, and Martinez fails to identify
48
In fact, according to the trial testimony, the IRS went forward and assessed certain
penalties against Nathaniel.
49
582 F.2d 1356, 1366 (5th Cir. 1978) (en banc).
50
Id.
19
No. 07-31163
sufficiently a detriment to the partnerships.51 Given that Hoyt obtained nothing
of true value and that what he did obtain was not contrary to the interests of the
partnerships, we think the alleged quid pro quo is too slender a reed to support
a conclusion that the IRS knew Hoyt was placing his interests above those of his
partners.
The final basis for the bankruptcy court’s finding of a conflict was that
Hoyt was attempting to stall the IRS and delay the issuance of the final
adjustments. This finding was based on the conclusion that it was in Hoyt’s
interest to delay the issuance of the adjustments as long as possible, but it was
in the partners’ interest to have the proceedings completed quickly. The court
relied in part on a Ninth Circuit decision that also involved Hoyt and allegedly
invalid extensions on the limitations period for issuing adjustments. See River
City Ranches # 1 Ltd. v. Comm’r.52
That case, known as River City Ranches II, concerned similar extensions
that Hoyt granted to the IRS but for different partnerships. The Ninth Circuit
remanded to the tax court for discovery on whether Hoyt acted under a disabling
conflict.53 Although it did not hold that there was a conflict, the Ninth Circuit
speculated that the partners might have opposed an extension on the limitations
period and preferred quickly issued adjustments because the sooner the IRS
issued them, the more difficult it would be for the IRS to defend them.54 It also
noted that even if the IRS was able to defend the adjustments, it would be in the
51
See Madison Recycling, 295 F.3d at 288 (noting that the tax payer must show that
an extension of the limitations period is invalid and that the burden of persuasion “remains
always with the taxpayer”).
52
401 F.3d 1136 (9th Cir. 2005).
53
Id. at 1143.
54
Id.
20
No. 07-31163
partners’ interest to avoid delay in order to minimize penalties and interest.55
Finally, the court reasoned that it would be in the partners’ interest to learn
from the adjustments that Hoyt was “looting the partnerships,” noting that
adjustments issued for other partnerships had prompted partners to withdraw
and initiate civil suits against Hoyt.56 In contrast, the court noted that Hoyt’s
preference would be to delay the issuance of adjustments in order to avoid
tension with his partners and perpetuate his fraud for as long as possible.57
Here, the bankruptcy court found this reasoning persuasive and held that Hoyt’s
pattern of delay and non-cooperation with the IRS indicated a disabling conflict
of interest in granting the extensions.
Although in hindsight Hoyt may have wanted to delay the adjustments for
his own reasons, we think that in light of all the circumstances the grant of the
extensions was not the kind of action that should have prompted the IRS to
believe that Hoyt’s interests were contrary to those of his partners. We think it
is incorrect to say categorically that the partners and Hoyt had divergent
interests as to when the adjustments were issued. Any difficulty that the IRS
might have had in subsequent tax court proceedings in defending adjustments
issued without an extension could have benefitted both Hoyt and the partners
because, as in the Bales case, a loss by the IRS would allow Hoyt’s business to
continue and allow the partners to take their deductions. Furthermore, both
Hoyt and the partners would still risk losing any subsequent tax court
proceedings because the IRS could have continued to press the adjustments and
urge the tax court to determine partnership items. See PAA Mgmt., Ltd. v.
55
Id.
56
Id.
57
Id.
21
No. 07-31163
United States. 58 But Agent Johnson testified that the extensions for the
adjustments could have been beneficial to the partners (as well as Hoyt) because
they could have given the partnerships more time to document and support any
legitimate deductions. In short, we think the speculation about the effect of the
adjustments cuts both ways, and we are not willing to hold as a matter of law
that there was a disabling conflict.
We are also not persuaded that the adjustments necessarily would have
given the partners notice of Hoyt’s fraud so as to influence a decision to take
protective action. In this case, the IRS sent numerous notices to Martinez
informing him of its view that Hoyt had taken improper deductions in preparing
the partnership returns. Martinez contends that there was no specific notice of
Hoyt’s lying about the value and number of cattle. Beginning in 1988, however,
the IRS informed Martinez that it believed Hoyt’s claimed deductions and
credits were not allowable, and it referred to penalties for overvaluation. It also
advised Martinez that he may wish to seek his own adjustment or to consult
with an accountant or attorney. The record contains an affidavit from Martinez
showing that as late as September 1993 Martinez maintained, based in part on
the Bales case, that the partnerships were not abusive tax shelters. He
specifically referred to his belief that the cattle had not been overvalued.
Martinez also testified before the bankruptcy court that he was aware the IRS
took the position that there was a problem with the size of the cattle herd. Yet
Martinez took no action of his own to address these matters. We therefore do
not see that the IRS knew Martinez’s interests diverged from those of Hoyt or
58
962 F.2d 212, 218–19 (2d Cir. 1992) (“The FPAA is not ‘final’ in the sense that its
issuance necessarily obviates the need for further information, brings the curtain down on the
IRS’s administrative or investigative role, or muzzles the IRS from requesting that the court
invoke its authority finally to determine partnership items.”).
22
No. 07-31163
that he had a significant conflict with Hoyt over adjustments issued without an
extension.59
The evidence here showed that the IRS firmly believed Hoyt was dishonest
and held that belief almost from the time it began auditing him in 1980. But the
IRS’s ability to deal with a tax matters partner and rely on his actions on behalf
of the partnership is critical for the effective operation of the current tax system.
The circumstances here did not reveal to the IRS a substantial gulf between the
tax matters partner’s interests and the interests of the partners. The grant of
an ex ten sion on th e lim itations p eriod is often “a rou tin e
accommodation—signing a waiver in order to avoid immediate assessment by
the IRS.”60 We do not think the totality of the circumstances in this case clearly
revealed to the IRS the tax matters partner’s inherent conflict and incentive to
breach his fiduciary duty to the partnership.
59
Following the Ninth Circuit’s remand in River City Ranches II, the tax court found
that Hoyt had a disabling conflict when granting extensions on the limitations period but ruled
in favor of the Government on other grounds. See River City Ranches #1 Ltd. v. Comm’r, 94
T.C.M. (CCH) 1, 2007 WL 1891595 (2007) (River City Ranches III). The tax court found a
conflict essentially by adopting the reasoning upon which the Ninth Circuit had speculated in
River City Ranches II, i.e. that it was in the partners’ interest to have the adjustments issued
sooner rather than later. The tax court cited the cattle headcount as evidence of the IRS’s
knowledge of Hoyt’s fraud but cited no evidence establishing what was in the partners’
interest. See id. at *13–14. In this case, as noted above, Agent Johnson testified that the
extensions on the adjustments could have benefitted the partners by giving the partnerships
a chance to document legitimate deductions. He also testified that matters are typically
settled at the administrative level faster than if a case proceeds to tax court. That being so,
it could have been in the partners interest to extend the audits and adjustments because they
might reach a quicker settlement and thereby realize savings of interest and penalties. It is
not so speculative to think the extension of the adjustments potentially could have resulted
in this benefit to the partners given that the tax court cases for the 1987 to 1989 tax years
were still pending when Martinez filed the instant adversary action in 2003. In any event, we
note that the Ninth Circuit recently affirmed the tax court’s decision in River City Ranches III
but did not reach the question of Hoyt’s conflict of interest. River City Ranches v. Comm’r,
2009 WL 498662, at *2 n.6 (9th Cir. Feb. 26, 2009) (unpublished).
60
Phillips, 272 F.3d at 1175.
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No. 07-31163
For the foregoing reasons we AFFIRM the district court’s affirmance of the
bankruptcy court’s holding that Martinez’s tax liabilities were not discharged for
the years 1990 to 1993. We REVERSE the court’s holding that the tax matters
partner’s grant of extensions of the limitations period were invalid and that
Martinez’s tax liabilities were discharged for the years 1987 to 1989. It is the
judgment of this court that none of these tax liabilities has been discharged.
24