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Rock v. United States

United States District Court, W.D. Texas, Austin Division

June 26, 2018

ROBERT ROCK, VERREE ROCK, Plaintiffs,
v.
UNITED STATES OF AMERICA, Defendant.

          ORDER

          SAM SPARKS SENIOR UNITED STATES DISTRICT JUDGE.

         BE IT REMEMBERED on this day the Court reviewed the file in the above-styled case, and specifically the United States of America (the Government's Motion for Summary Judgment [#56], Plaintiffs Robert Rock and Verree Rock's Response [#60] in opposition, the Government's Reply [#62] in support, and Plaintiffs' Sur-Reply [#65-1 ][1] thereto, as well as Plaintiffs' Motion for Summary Judgment [#58], the Government's Response [#59] in opposition, and Plaintiffs' Reply [#64] thereto. Having reviewed the documents, the governing law, and the file as a whole, the Court now enters the following opinion and orders.

         Background[2]

         This case is one of many tax cases relating to American Agri-Corp (AMCOR) partnerships of the 1980s. The AMCOR agricultural partnerships generally allowed partners to report significant losses on tax returns because "farming expenses typically exceeded any income realized from farming activities." Duffie v. United States, 600 F.3d 362, 367 (5th Cir. 2010). The Internal Revenue Service (IRS) began investigating AMCOR partnerships in the late 1980s "to determine whether they were impermissible tax shelters." Id.

         I. Statutory Background

         This case centers on the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), which amended the Internal Revenue Code.[3] A brief review of TEFRA is necessary to provide context for this decision.

         A. TEFRA and Partnerships

         In relevant part, TEFRA regulates the tax treatment of partnerships. As the United States Supreme Court has explained:

A partnership does not pay federal income taxes; instead, its taxable income and losses pass through to the partners. 26 U.S.C. § 701. A partnership must report its tax items on an information return, § 6031(a), and the partners must report their distributive shares of the partnership's tax items on their own individual returns, §§ 702, 704.

United States v. Woods, 134 S.Ct. 557, 562 (2013). Congress enacted TEFRA, in part, to provide the IRS with a method for correcting errors on a partnership's returns in a single, unified proceeding. Id. at 562-63. "TEFRA requires partnerships to file informational returns reflecting the partnership's income, gains, deductions, and credits. Individual partners then report their proportionate share of the items on their own tax returns." Rodgers v. United States, 843 F.3d 181, 184 (5th Cir. 2016) (quoting Irvine v. United States, 729 F.3d 455, 459 (5th Cir. 2013)).

         As an overarching framework, "TEFRA established three categories for items considered in the tax treatment of a partnership: partnership items, nonpartnership items, and affected items." Id. (citing 26 U.S.C. § 623l(a)(3)-(5)) (internal quotation marks omitted). TEFRA defines a "partnership item" as "any item required to be taken into account for the partnership's taxable year under any provision of Subtitle A to the extent regulations prescribed by the Secretary provide that, for purposes of [subtitle F], such item is more appropriately determined at the partnership level than at the partner level." 26 U.S.C. § 6231(a)(3). TEFRA's corresponding regulations provided that items "more appropriately determined at the partnership level" include the gains, losses, deductions, and credits of a partnership. 26 C.F.R. § 301.6231(a)(3)-1. The term "partnership item" also "includes the accounting practices and the legal and factual determinations that underlie the determination of the amount, timing, and characterization of items of income, credit, gain, loss, deduction, etc." 26 C.F.R. § 3Ol.623l(a)(3)-l(b).

         By contrast, a "nonpartnership item" is "an item which is (or is treated as) not a partnership item." 26 U.S.C. § 6231(a)(4). "The tax treatment of nonpartnership items requires partner-specific determinations that must be made at the individual partner level." Duffle, 600 F.3d at 366. Finally, an "affected item" is "any item to the extent such item is affected by a partnership item." 26 U.S.C. § 6231(a)(5).

         B. TEFRA Two-Stage Proceedings

         TEFRA created a two-stage procedure for the IRS to revise partnership-related tax matters: first, the IRS assesses partnership items, making any adjustments it deems necessary, and then the IRS may initiate proceedings against individual partners. Rodger s, 843 F.3d at 184. If the IRS decides to adjust partnership items during the first stage, it must notify the individual notice partners by issuing a Notice of Final Partnership Administrative Adjustment (FPAA). Id.

         Partners can challenge a FPAA in partnership-level proceedings. Rodgers, 843 F.3d at 184. A partnership's tax matters partner (TMP) has the exclusive right to file a petition for readjustment of the partnership items in United States Tax Court or in a federal district court within ninety days of the FPAA's issuance. Id. at 184-85 (citing 26 U.S.C. § 6231(a)(7)). If the TMP does not challenge the FPAA within the ninety days, non-TMP notice partners may file a petition for readjustment within the following sixty days. Id. (citing 26 U.S.C. § 6226(b)(1)). Regardless of who files it, if a partnership-level challenge is filed, each partner is deemed a party to the case and is bound by its outcome absent an agreement to the contrary. Id. at 185 (citing 26 U.S.C. § 6226(c)(1)); see also Crnkovich v. United States, 202 F.3d 1325, 1328 (Fed. Cir. 2000).

         In a partnership-level proceeding, the Tax Court has jurisdiction to determine all partnership items for the tax year to which the FPAA relates. Duffie, 600 F.3d at 367. The Tax Court also has jurisdiction to determinate the proper allocation of the partnership items among the partners. Id. (citing 26 U.S.C. § 6226(f)). For tax years before 1997, the Tax Court does not have jurisdiction over nonpartnership items or over affected items. Id.

         Partners and the IRS may reach an agreed decision in the Tax Court on partnership items in multiple ways. See Tax Ct. R. 248. First, the TMP may enter into a settlement agreement with the IRS and certify that no party objects to the entry of decision; such a settlement, filed with the Court, binds all the parties.[4] Tax Ct. R. 248(a). Alternatively, the IRS may move for entry of a decision if (1) all the participating partners agree or do not object and (2) the TMP agreed to the proposed decision without certifying an objection. Tax Ct. R. 248(b)(1). Any party that subsequently objects to the entry of decision must file such objection with the Tax Court within sixty days of the IRS's motion. Finally, a partner may "individually settle[] his or her partnership tax liability with the IRS, [and] that partner will no longer be able to participate in the partnership level litigation, and will be bound instead by the terms of the settlement agreement." Rodgers, 843 F.3d at 184.

         Once adjustments to the partnership items become final, the IRS may begin partner-level proceedings to adjust the affected tax liability of the individual partners. Woods, 134 S.Ct. at 563. Procedural next steps depend on whether affected items qualify as computational adjustments or as substantive affected items. A computational adjustment merely requires a mechanical change in the tax liability of a partner to properly reflect adjustment of a partnership item. Duffie, 600 F.3d at 366. Such an adjustment can only be made at the conclusion of the partnership level proceeding and can be applied without any factual determination at the partner level. Id. By contrast, a substantive affected item "is dependent upon factual determinations (other than a computation) relating to an adjustment made at the partner level" and requires "fact-finding particular to the individual partner." Id. at 366, 385. (quotation omitted).

         Where the affected item is substantive, the IRS is required to follow the deficiency procedures articulated in subchapter B of the Internal Revenue Code, which include mailing the partner a statutory notice of deficiency. 26 U.S.C. § 623O(a)(2)(A)(i). But where the affected items are only computational adjustments, deficiency procedures do not apply and the IRS is not required to issue a statutory notice of deficiency to the individual partner. Duffie, 600 F.3d at 385 (citing Woody v. C.I.R., 95 T.C. 193, 202 (1990)). Instead, the IRS is merely required to mail the partner a notice of computational adjustment. Id.

         C. Statute of Limitations

         Generally, the IRS has three years from the filing date of a tax return to assess taxes. See 26 U.S.C. § 6501(a). When an additional tax assessment is attributable to a partnership item or an affected item, the three-year statute of limitations runs from the later of the date the partnership filed its informational return or the date such return was due. 26 U.S.C. § 6229(a). The Fifth Circuit has determined § 6229(a) is not "an independent statute of limitations for issuing FPAAs." Curr-Spec Partners, L.P. v. C.I.R.,579 F.3d 391, 393 (5th Cir. 2009). The IRS may issue an FPAA at any time, but such FPAA "may affect only those partners whose ...


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