Mellow Partners, A Partnership v. Cmsnr. IRS
890 F.3d 1070
| D.C. Cir. | 2018Background
- Mellow Partners was a short-lived (Nov–Dec 1999) general partnership formed by two single-member LLCs (68th Street and Hunters Crest); the LLCs did not elect corporate treatment and were treated as disregarded entities for federal tax purposes.
- Mellow filed a Form 1065 reporting the two LLCs as partners and answered “No” to whether TEFRA applied; the IRS audited, issued an FPAA for 1999, disallowed losses as sham transactions, zeroed outside bases, and asserted accuracy-related penalties under § 6662.
- Mellow petitioned the Tax Court, moved to dismiss for lack of jurisdiction asserting it qualified as a “small partnership” (≤10 partners each an individual, C corporation, or estate) because the LLCs were disregarded and therefore their individual owners (Berlow and Melton) were the true partners.
- The Tax Court denied dismissal, held the partners were the LLCs (not their owners) and that single-member disregarded LLCs are “pass-thru partners,” making the small-partnership exception inapplicable; it entered a decision upholding most FPAA adjustments and imposed penalties.
- On appeal to the D.C. Circuit Mellow challenged (1) the TEFRA jurisdictional ruling and (2) the imposition of penalties arguing lack of written supervisory approval under § 6751(b)(1).
- The D.C. Circuit affirmed: it found the record and stipulations treat the LLCs as the partners, deferred to the IRS (and Revenue Ruling 2004–88) that disregarded single-member LLCs qualify as pass-thru partners under § 6231(a)(9) (so TEFRA applies), and held Mellow waived its § 6751(b)(1) challenge by consenting to the Tax Court decision without reserving that issue.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether Mellow qualified for the TEFRA "small-partnership" exception (≤10 partners who are individuals/C corps/estates) | Mellow: disregarded single-member LLCs are "nullities" for tax purposes; the LLCs' individual owners are the partners, so Mellow had two individual partners and fits the small-partnership exception | IRS: partnership agreement, K-1s, and stipulation identify the LLCs as partners; Treasury regulation and IRS guidance treat a partnership as ineligible for the exception if any partner is a "pass-thru partner," and disregarded single-member LLCs are pass-thru partners | Affirmed for IRS: LLCs were the partners; IRS reasonably interprets §6231(a)(9) and Treas. Reg. §301.6231(a)(1)-1 to include disregarded single-member LLCs as pass-thru partners, so TEFRA applies |
| Whether IRS’s accuracy-related penalties should be vacated for lack of written supervisory approval under §6751(b)(1) | Mellow: IRS did not obtain the written supervisory approval required by §6751(b)(1); relies on post-judgment developments (e.g., Chai) for timing rule | IRS: §6751(b)(1) requirement is subject to litigation over timing, but Mellow failed to raise the issue in Tax Court and consented to a decision imposing penalties | Affirmed in part: Court declined to reach the merits because Mellow waived/preserved no attack on penalties in Tax Court by consenting to the decision without reserving the issue; refusal to remand |
Key Cases Cited
- McNamee v. Dep’t of Treasury, 488 F.3d 100 (2d Cir.) (discussing entity classifications for tax purposes)
- Petaluma FX Partners, LLC v. Comm’r, 792 F.3d 72 (D.C. Cir.) (describing TEFRA partnership-item adjustments and proceedings)
- Seaview Trading, LLC v. Comm’r, 858 F.3d 1281 (9th Cir.) (holding disregarded single-member LLCs are pass-thru partners under §6231(a)(9))
- United States v. Cleveland Indians Baseball Co., 532 U.S. 200 (2001) (revenue rulings reflecting consistent agency interpretations attract substantial deference)
- Skidmore v. Swift & Co., 323 U.S. 134 (1944) (agency interpretations merit respect according to persuasiveness)
- Auer v. Robbins, 519 U.S. 452 (1997) (deference to agency interpretation of its own regulations unless plainly erroneous)
- Polm Family Foundation, Inc. v. United States, 644 F.3d 406 (D.C. Cir.) (deferring to IRS interpretation of Treasury regulations)