ALPHA I, L.P, (BY AND THROUGH ROBERT SANDS, A NOTICE PARTNER), BETA PARTNERS, L.L.C., (BY AND THROUGH ROBERT SANDS, A NOTICE PARTNER), R, R, M & C PARTNERS, L.L.C., (BY AND THROUGH R, R, M & C GROUP, L.P., A NOTICE PARTNER), R, R, M & C GROUP L.P., (BY AND THROUGH ROBERT SANDS CHARITABLE REMAINDER UNITRUST – 2001, A NOTICE PARTNER), CWC PARTNERSHIP I, (BY AND THROUGH TRUST FBO ZACHARY STERN U/A FIFTH G. ANDREW STERN AND MARILYN SANDS, TRUSTEES, A NOTICE PARTNER), MICKEY MANAGEMENT, L.P., (BY AND THROUGH MARILYN SANDS, A NOTICE PARTNER), M, L, R & R, (BY AND THROUGH RICHARD E. SANDS, TAX MATTERS PARTNER), Plаintiffs-Cross Appellants, v. UNITED STATES, Defendant-Appellant.
2011-5024, -5030
United States Court of Appeals for the Federal Circuit
Decided: June 15, 2012
Appeals from the United States Court of Federal Claims in consolidated case nos. 06-CV-407, 06-CV-408, 06-CV-409, 06-CV-410, 06-CV-411, 06-CV-810, and 06-CV-811, Chief Judge Emily C. Hewitt.
FRANCESCA U. TAMAMI Attorney, Tax Division, United States Department of Justice, of Washington, DC, argued for defendant-appellant. With her on the brief were GILBERT S. ROTHENBERG, Acting Deputy Assistant Attorney General, and Kenneth L. Greene, Attorney.
Before RADER, Chief Judge, NEWMAN, and O‘MALLEY, Circuit Judges.
O‘MALLEY, Circuit Judge.
The U.S. Court of Federal Claims dismissed the Internal Revenue Service‘s determination that certain taxpayers’ transfers of their partnership interests to trusts were shams because the court believed it lacked jurisdiction to address the IRS‘s determination at the partnership level. The United States appeals that ruling in Case No. 2011-5024. We reverse the Court of Federal Claims‘s dismissal. The identity of the true partners in the partnership at issue appropriately is determined at the partnership level because, on the particular facts of this case, partnership identity could affect the distributive shares reported to the partners.
After this action commenced, the taxpayers conceded certain capital gain and loss adjustments imposed by the IRS and moved for summary judgment on the valuatiоn
Finally, the Court of Federal Claims granted the government‘s motion for summary judgment with respect to additional penalties for negligence, substantial understatement, and failure to act reasonably and in good faith, and imposed a twenty-percent penalty on the taxpayers. The taxpayers appeal that ruling in Case No. 2011-5030. We dismiss the taxpayers’ appeal as premature. If the Court of Federal Claims concludes on remand that the forty-percent valuation misstatement penalty applies, that valuation misstatement penalty could render moot the propriety of the twenty-percent penalty that is the subject of the taxpayers’ cross appeal.
I
This case arises from two so-called “Son-of-BOSS” transactions, as well as a transaction involving charitable remainder unitrusts (“CRUTs“), conducted by the heirs of the late Marvin Sands, the founder of Constellation Brands, Inc. In a Son-of-BOSS transaction, a taxpayer attempts to realize tax benefits by transferring assets encumbered by significant liabilities to a partnership in an attempt to increase the partner‘s basis in the partnership. See Stobie Creek Invs. LLC v. United States, 608 F.3d 1366, 1368-71 (Fed. Cir. 2010); Korman & Assocs. v. United States, 527 F.3d 443, 446 n.2 (5th Cir. 2008).
In this case, Marvin Sands‘s heirs owned stock in Constellation. In the first Son-of-BOSS transaction, they used several partnerships to convert approximately $66 million in taxable gain that they anticipated receiving from the sale of their stock into large capital losses. The heirs also prearranged for their partnership interests to be held temporarily by tax-exempt CRUTs at the time of the sale so that, as the government alleges, any gain that might be recognized from the sale would escape taxation. The CRUTs were terminated shortly after they were formed, and the assets of the CRUTs, including the sale proceeds, were distributed to the heirs, purportedly tax free. In the second Son-of-BOSS transaction, the heirs sought to generate significant capital losses to offset other income, again through the use of various partnerships.
In notices of final partnership administrative adjustment (“FPAAs“) issued to the partnerships involved in the Son-of-BOSS transactions, the IRS determined that the transactions should be disregarded and that the transfers of the partnership interests to the CRUTs were shams. The IRS also asserted various basis and capital gain and
The partnerships invоlved in the Son-of-BOSS transactions initially challenged the IRS‘s adjustments to the basis, capital gain, and capital loss calculations. In an amended complaint, however, the partnerships conceded the capital gain and loss adjustments on the purported basis of
A
During 2001 and 2002, the years at issue, Constellation was a leading producer and marketer of alcoholic beverages in North America and the United Kingdom, with gross sales exceeding $3 billion in fiscal year 2001. Constellation was founded and owned by the late Marvin Sands. After his death, the following fаmily members held a controlling interest in Constellation through stock
1
The heirs received tax advice from The Heritage Organization, LLC, which designed and directed the implementation of the two Son-of-BOSS transactions. The heirs implemented the first Son-of-BOSS transaction as follows. Between August 21 and 23, 2001, they established brokerage accounts with Paine Webber. Through those accounts, they collectively sold short approximately $85.6 million of U.S. Treasury Notes.1 On August 27, 2001, the Children‘s Trusts assigned their portion of the short-sale proceeds and the obligation to close out the short sale to CWC Partnership I (“CWC“), a preexisting family investment partnership. On August 28, 2001, the heirs and CWC contributed (i) the proceeds from the short sale, (ii) the obligation to close out the short sale, and (iii) a total of 2,000,000 shares of Constellation stock to R,R,M & C Group, L.P. (“RRMC Group“), a new partnership created at the direction of Heritage. The general partner of RRMC Group was R,R,M & C Management Corporation (“RRMC Corp.“), an entity created by Richard and Robert on August 23, 2001. For its claimed 0.1% interest in
On August 31, 2001, RRMC Group, in turn, contributed the Constellation stock, the short-sale proceeds, and the obligation to close out the short sale to R,R,M & C Partners, L.L.C. (“RRMC Partners“), another new entity established at the direction of Heritage. RRMC Group held a 99.7163% interest in RRMC Partners. The remaining interest was held by Gloria Robinson, the mother of the heirs’ accountant.
On September 6, 2001, RRMC Partners closed out the short-sale position at a net loss of $425,565. On September 10, 2001, RRMC Group purchased Robinson‘s interest in RRMC Partners, thereby effecting a termination of RRMC Partners. The government alleges that, as a result of this transaction, RRMC Group claimed that its basis in the Constellation stock increased by approximately $85.6 million, from $9 million to $94.7 million.
2
In connection with the first Son-of-BOSS transaction, the heirs prearranged to channel the sale of the Constellation stock through tax-exempt CRUTs. A CRUT is a charitable trust that provides an income beneficiary, often the grantor, annual payments for a fixed term. At the end of the fixed term, a charity receives the remainder interest. See
On September 21, 2001—eleven days after RRMC Partners had terminated and distributed the Constellation stock back to RRMC Group with the increased basis—Richard, Robert, Marilyn, and CWC each created a CRUT with a twenty-year term. Richard and Robert were
On October 1, 2001, RRMC Group sold the Constellation stock for approximately $75 million. The government claims that the actual basis of the stock was approximately $9 million and that RRMC Group should have realized a $66 million gain. As the government further claims, however, RRMC Group claimed a $20 million loss because the heirs inflated the basis through the Son-of-BOSS transaction.
On January 28, 2002, the Sands Supporting Foundation was designated as the charitable beneficiary of the CRUTs. On February 22, 2002, that charity designation was revoked, and the Educational and Health Support Fund, an entity created by Robert and Richard on the same day, was named as the charitable beneficiary. Updated appraisals valued each CRUT‘s partnership interest at $5,482,334. Based upon the updated appraisals, on February 27, 2002, Richard, Robert, Marilyn, and CWC purchased from the Educational and Health Support Fund the remainder interests in the CRUTs for $550,000 each. This had the effect of terminating each CRUT (because the income and remainder interests were merged), and the partnership interests in RRMC Group, which held the $75 million from the sale of the Constellation stock, were distributed back to the heirs and CWC.
3
In the second Son-of-BOSS transaction, on December 3, 2001, the heirs and CWC formed Alpha I, L.P. (“Alpha“), a limited partnership in which they held a cumulative 99.9% interest. The remaining 0.1% interest was held by RRMC Corp. as general partner. By agreement dated December 10, 2001, Alpha and Gloria Robinson, who was involved in the first Son-of-BOSS transaction, formed Beta Partners L.L.C. (“Beta“), with Alpha holding a 99.0043% interest and Robinson holding the remaining 0.9957% interest. On December 12, 2001, the heirs and CWC collectively transferred approximately $1.1 million to their respective Paine Webber accounts. On the same day, the heirs and CWC sold short approximately $44 million of U.S. Treasury Notes. On December 13, 2001, the heirs and CWC contributed the short-sale proceeds, the short-sale obligations, and $1.24 million to Alpha. Shortly therеafter, RRMC Corp. contributed $2,582 to Alpha.
On December 17, 2001, Alpha purchased 67,525 shares of Corning, Inc., common stock for $595,570.50 and 33,400 shares of Yahoo, Inc., common stock for $599,530. On December 20, 2001, Alpha contributed its assets, including the short-sale proceeds, the short-sale obligations, and the Corning and Yahoo stock, to Beta. On December 27, 2001, Beta closed out the short-sale position, realizing a net gain of $90,018. On the same date, Alpha purchased Robinson‘s 0.9957% interest in Beta, causing the termination of Beta. As a result of these transactions, Alpha claimed it had a basis in the Corning stock of $23,230,361 and a basis in the Yahoo stock of $22,262,094.
B
The IRS audited the partnerships’ 2001 and 2002 partnership returns. In 2005 and 2006, the agency issued FPAAs denying the losses from the transactions. With respect to the first Son-of-BOSS transaction, the IRS adjusted the basis of the Constellation stock and determined that the sale of the stock resulted in capital gains rather than capital losses. The IRS listed several alternative theories supporting the adjustments, including
In a section titled “I.R.C. § 465 At Risk Rules,” the IRS further stated in each FPAA that “[i]t is determined that none of the transactions of the Partnership increases the amount considered at-risk for an activity under I.R.C.
Finally, in the FPAAs issued to the partnerships involved in the first Son-of-BOSS/CRUTs transaction, the IRS also asserted that the transfers of the RRMC Group partnership interests to the CRUTs should be disregаrded as shams. Consequently, the IRS asserted, the proceeds from RRMC Group‘s sale of the Constellation stock should not flow through to the CRUTs, but instead should flow through to the heirs and CWC as partners in RRMC Group.
C
In their complaints, the partnerships challenged each of the determinations contained in the FPAAs. The partnerships engaged in the first Son-of-BOSS/CRUTs transaction filed a motion to dismiss the determination that the transfers to the CRUTs were shams. They argued that the identity of RRMC Group‘s partners is not a “partnership item,” such that the court lacked jurisdiction under
The partnerships involved in both Son-of-BOSS transactions challenged the forty-percent gross valuation misstatement penalty. With respect to the FPAAs’
The partnerships, however, later filed a motion to amend their complaints in which they conceded the capital gain and loss adjustments on the purported basis of
The partnerships then moved for summary judgment on the valuation misstatement penalty. The Court of Federal Claims granted the motion, holding that the partnerships’ concession of the capital gain and loss adjustments on the basis of
The parties also filed cross-motions for summary judgment on the government‘s remaining penalty claims: the twenty-percent negligence penalty and the twenty-percent substantial-understatement-of-tax penalty. The Court of Federal Claims held that both penalties applied. The court found that the partnerships had engaged in a tax shelter based on “the transfer of short sale proceeds to RRMC Group without the transfer of the related contingent obligations . . . .”2
On September 16, 2010, the Court of Federal Claims entered final judgment consistent with its various opinions.
II
The Court of Federal Claims erred when it dismissed the IRS‘s determination that the transfers of the partners’ interests in RRMC Group to the CRUTs were shams. The court‘s ruling was on a question of law, which we review de novo. Keener v. United States, 551 F.3d 1358, 1361 (Fed. Cir. 2009) (“The Court of Federal Claims’ decision to grant [a] . . . motiоn to dismiss for lack of jurisdiction is a matter of law, which this court reviews de novo.“).
In determining whether the transfers were shams, the Court of Federal Claims was asked to determine the
A
Whether the Court of Federal Claims may exercise jurisdiction to determine the identities of the partners in RRMC Group turns on whether partner identity must be determined at the partnership or partner level. The statutory framework governing partnership- and partner-level determinations provides the foundation on which that issue must be resolved.
Partnerships are pass-through entities, meaning they do not pay federal income tax. Rather, all income, deductions, and credits are allocated among the individual partners.
In the past, the differing tax treatment of partnerships and their partners resulted in duplicative audits and litigation, and, often, inconsistent treatment of partners in the same partnership. See Anisa Afshar, The Statute of Limitations for the TEFRA Partnership Proceedings: The Interplay Between Section 6229 and Section
When the IRS disagrees with a partnership‘s reporting of any partnership item, it must issue an FPAA before making any assessments attributable to that item against the partners.
If a petition contesting the FPAA is filed, the reviewing court‘s jurisdiction at the partnership-level proceeding is limited to certain categories.
B
A court with which a petition is filed in accordance with this section shall have jurisdiction to
determine all partnership items of the partnership for the partnership taxable year to which the notice of final partnership administrative adjustment relates, the proper allocation of such items among the partners, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item.
[A]ny item required to be taken into account for the partnership‘s taxable year under any provision of subtitle A [of the tax code] to the extent regulations prescribed by the Secretary provide that, for purposes of this subtitle, such item is more appropriately determined at the partnership level than at the partner level.
First, we concluded in Keener that the reference in Section 6231(a)(3) to Subtitle A of the tax code is ambigu-
Thus, because the statute expressly refers to the regulations with respect to the second prong, and our precedent requires Chevron deference to those regulations governing the first, we look to the regulations as the primary source for the definition of a “partnership item.”
Treasury Regulation § 301.6231(a)(3)-1(a) implements the statutory definition of “partnership item.” Subsection (a) of that provision defines a partnership item, in relevant part, as “[t]he partnership aggregate and each
The statutory requirement that a partnership file an information return establishes a close relationship between allocation and partner identity. See
One regional circuit that has considered this issue and the Tax Court have come to the same conclusion. In Katz v. Commissioner, 335 F.3d 1121, 1128-29 (10th Cir. 2003), the Tenth Circuit recognized the relationship between allocation and partner identity. Id. at 1123. There, the taxpayer declared bankruptcy and attempted to allocate his share of losses incurred by partnerships in which he was a partner between his bankruptcy estate and himself. Id. The IRS determined that the losses should have been allocated entirely to the bankruptcy estate and attempted to challenge the allocation in a partner-level deficiency proceeding. Id. at 1124-25. The Tenth Circuit rejected the partner-level challenge. The court observed that the partnership was required to specify a partner‘s income and losses on its partnership return. Id. at 1128-29. That task could not be accomplished unless allocation were conducted at the partnership level, the court observed. “What is important is that the debtor was a partner during part of the partnership year, so the partnership returns must set forth the debtor‘s share of income, loss, etc.” Id. at 1128.
The Tax Court, similarly, has found that partner identity can be necessary to properly allocate the partnership items. In Blonien, the Tax Court found that partner identity was more appropriately determined at the partnership level because it could affect allocation of partnership items among the partners in that action. 2002 U.S. Tax Ct. LEXIS 33, at *20 n.6. Blonien was a partner-level proceeding. The government argued that the court lacked
This case is similar to Blonien and Katz. Here, it is possible that the distributive shares reported to the partners of RRMC Group would change if one or more of the CRUTs were disregarded. During the 2001 tax year, four heirs, four CRUTs, and RRMC Management Corp. were listed as the partners of record on RRMC Group‘s partnership return. If the Court of Federal Claims were to determine that some of the heirs’ transfers to the CRUTs were shams, each remaining partner‘s share of the partnership items could change. If the court were to disregard one, two, or three of the CRUTs, for example, the distributive shares would be different than if the court were to disregard all of the CRUTs. In such a scenario, the court would be required to decide who should report the disregarded CRUT‘s share. Thus, while the validity of the CRUTs would not impact the partnership‘s aggregate income, it could affect the remaining parties’ individual shares of that income.
Even in cases in which the Tax Court determined that partner identity was not a partnership-level determination, it recognized that the inquiry turns on the facts of the particular case and the effect that partner identity
would have on the distributive shares. In Grigoraci, the IRS asserted in its FPAAs that certain corporate partners were shams and sought to reallocate shares to certain individuals. 2002 Tax Ct. Memo LEXIS 207, at *3-4. The taxpayers challenged the FPAAs in a partnership-level proceeding in the Tax Court. Id. at *1-4. The government moved to dismiss on the ground that the identity of the partners was a partner-level issue over which the Tax Court lacked jurisdiction in the partnership-level proceeding. Id. at *2-3. The Tax Court began its analysis by stating that “the hallmark of a partnership item is that it affects the distributive shares reported to the other partners.” Id. at *13. To that end, the Tax Court inquired whether identifying individuals rather than corporations as the true partners would affect the distributive shares. Id. at *15.The Tax Court noted that no dispute existed concerning the aggregate income, gain, loss, deductions, and credits of the partnership. Id. at *16. It further noted that, even if the income were reallocated to the individual partners, “there [would be] no dispute about the amount of the allocations made to the partners . . . .” Id. at *16-17. Because the allocations would have no effect on “either the partnership‘s aggregate or each partner‘s share of income, gain, loss, deductions, or credits of the partnership,” the court concluded that partnership identity was not a partnership item on the facts of that case. Id. at *18. While the Tax Court found that the partner identification question at issue before it was a partner-level determination, the court made clear that it made that determination based on the particular facts of that case: “Under the circumstances of this case, we hold that a determination that the partners of record were not the true and actual partners is not a ‘partnership item . . . .‘” Id. at *21 (emphasis added).
The facts of this case are distinct from those in Grigoraci. RRMC Group was required to report its gain or loss from the sale of the Constellation stock on its partnership return. RRMC Group also was required to assign that gain or loss to its partners. The IRS‘s FPAAs challenged both the losses claimed by RRMC Group and its assignment of certain of those losses to the CRUTs. As discussed above, whether those losses were properly assigned to the CRUTs could affect the distributive shares reported to the remaining partners. This is an exercise that must be conducted at the partnership level.
The Court of Federal Claims relied on Grigoraci and another Tax Court case, Hang v. Commissioner, 95 T.C. 74 (1990), to conclude that RRMC Group‘s partners’ identities cannot be determined at the partnership level. Specifically, relying on Grigoraci, the Court of Federal Claims concluded that identification of the partners in this case would not affect the distributive shares. The court stated that, “[w]here ‘[t]here is . . . no dispute about the amount of the allocations made to the partners[,]’ . . . as is the case before the court[,] . . . [a]n item with ‘no effect on either the partnership‘s aggregate or each partner‘s share of income, gain, loss, deductions, or credits of the partnership’ is not a partnership item.” Alpha I, L.P. v. United States, No. 06-cv-407 (Fed. Cl. Oct. 9, 2008) (opinion and order at 19) (quoting Grigoraci, 2002 Tax Ct. Memo LEXIS 207, at *17-18, and Russian Recovery Fund Ltd. v. United States, 81 Fed. Cl. 793, 800 (2008)). While the trial court was correct to rely on the general rule set forth in Grigoraci, for the reasons noted above, its application of the facts at issue here to that rule was erroneous.
The Court of Federal Claims‘s reliance on Hang also is misplaced. In Hang, the Tax Court held that the iden
Because the father was not a shareholder of record, the Tax Court found that the IRS‘s proposed reallocation could not expressly fall within the scope of “the S corporation aggregate,” “each shareholder‘s share of,” or “any factor necessary to determine” the “income, gain, loss, deduction, or credit of the corporation.” Id. at 80. While the government argued that the Tax Court should find that the regulation nevertheless encompassed the proposed reallocation because the father was allegedly the beneficial owner of the corporation‘s stock and could therefore qualify as a shareholder for purposes of the regulation, the Tax Court declined to adopt that argument. Id. The court found that insufficient information existed at the corporate level to determine beneficial ownership: “[a]s a practical matter, there is no way for a corporation to determine who the beneficial owners of its stock are because the information necessary to make the determination would not be available at the corporate level where the beneficial owner of stock is not a shareholder оf record.” Id.
Here, the Court of Federal Claims equated the relationship of the heirs to the CRUTs to that of the sons to the father in Hang. It concluded that “the [RRMC] Group partnership is not in a position to go behind the transactions between a partner and its successor of record. Both are questions of succession to interests that appear to the court to require determination at the individual taxpayer level.” That analysis was incorrect, however. In Hang, the scenario expressly fell outside the scope of the regulatory definition of an S corporation item because the father was not a shareholder of record. The Tax Court was required, consequently, to address the IRS‘s alternative theory of beneficial ownership by inquiring whether all information was available at the partnership level to determine whether the father was the beneficial shareholder. Here, however, the scenario expressly falls within the regulation‘s definition of a partnership item because all parties who could be identified as true partners—the heirs, the CRUTs, and RRMC Corp.—are listed as partners of record on the partnership‘s 2001 information return, and the determination of the true partners in the partnership could affect the distributive shares attributed to one or more of those named partners.5 The fact that the distributive shares could be affected by the determination of the partners’ identity is sufficient to sweep the
Because partner identity in this case falls within the regulation‘s definition of a partnership item, the Court of Federal Claims erred in adding an additional layer to the analysis by requiring that “all information” necessary to determine the identity of RRMC Group‘s partners be available at the commencement of the partnership-level proceedings. The taxpayers defend the trial court‘s analysis, arguing that a court cannot make findings in a partnership-level proceeding on the intentions of the individual Sands family members and the trustees of their charitable funds when they engaged in the CRUT transactions. The taxpayers are wrong. The Court of Federal Claims can allow discovery and hear testimony in a partnership-level proceeding as long as the inquiry regards a partnership-level item, which we hold it does on these facts. Indeed, adjudicating this issue in a partnership-level proceeding is consistent with the congressional policy favoring that such issues be resolved in unified judicial proceedings. See Afshar, 64 Tax Law. 701;
C
The taxpayers next argue that the allocation among them will not change regardless of the identity of RRMC Group‘s true partners. They point out that the IRS proposed disregarding the four CRUTs and reallocating the items reported by RRMC Group among the four heirs in the same proportion they were allocated among the CRUTS. Each heir, in other words, would merely stand in the shoes of its CRUT and be allocated the same share
While the IRS did propose such an allocation, its proposal does not deprive the Court of Federal Claims of jurisdiction. The Court of Federal Claims exercises de novo review of an FPAA and is not bound to follow the IRS‘s proposal. See Jade Trading, LLC v. United States, 80 Fed. Cl. 11, 43 (2007). The Court of Federal Claims dismissed the portion of the FPAA at issue before it before it considered the FPAA‘s merits. At this stage, we cannot conclude with certainty that the trial court would accept the IRS‘s proposal if this matter were to proceed to trial.6
Tellingly, while the taxpayers argue that the allocation would not change under the IRS‘s proposal, they remain silent as to whether they agree with the IRS‘s proposal. They claim that “the government has not pointed to anything that suggests . . . [RRMC] Group‘s partnership items would be allocated to anyone other than the Sands family member who made the transfer to the CRUT,” but they do not reveal whether they would stipulate to such an allocation if the trial court were to consider the merits of it. Thus, the record leaves open a live issue concerning allocation, which the Court of Fed
The taxpayers also caution that the conclusion we reach here is tantamount to placing a continuing burden on partnerships to ascertain the identity of their partners. The taxpayers point out that many partnerships have hundreds or even thousands of partners whose partnership interests may be actively traded, and that Congress never intended to burden partnerships with the responsibility of ascertaining their “true” partners.
The taxpayers are correct—at least in the abstract. It is true, for example, that, after partners exchange their partnership interests, a partnership is not required to note such an exchange on its return until it is notified of the exchange.
The taxpayers are incorrect, however, in arguing that our holding, which is limited to the particular facts of this case, places a new and additional burden on all partnerships to ascertain the identity of their true partners. Congress created TEFRA proceedings such as this one to provide a vehicle for determining partner identity when partner identity is challenged by the IRS; sometimes that is appropriate at the partnership level and sometimes it is appropriate at the partner level, depending upon the circumstances. Partnerships do not bear the burden of identifying their true partners in all filings; rather, the
For the foregoing reasons, the identity of the partners in RRMC Group is appropriately determined at the partnership level.7
III
With respect to the forty-percent gross valuation misstatement penalty, the Court of Federal Claims erred when it granted the taxpayers summary judgment on that penalty. The Court of Federal Claims was wrong to conclude that it was not obligated to determine whether the taxpayers’ underpayments are attributable to a valua
The tax code provides that a penalty “shall be added” “to any portion of an underpayment of tax required to be shown on a return whiсh is attributable to . . . [a]ny substantial valuation misstatement.”
The statute requires that any underpayment of tax on which a valuation misstatement penalty is based be “attributable to” the valuation misstatement.
Thus, the partnerships’ alleged failure to report the alleged gains in this action is conceptually distinct from the issue presented in the context of
The Court of Federal Claims appeared to acknowledge that
The Court of Federal Claims cited several cases to support its decision to defer to the terms of the partner
In Todd, the Fifth Circuit affirmed the Tax Court‘s ruling that pеnalties sought for valuation overstatements did not apply because the taxpayers’ underpayments were not attributable to the valuation overstatements. 862 F.2d at 543. There, the IRS disallowed certain depreciation deductions and credits because the property in question had not been placed in service during the tax years in issue. Id. The IRS separately imposed the penalty for valuation overstatement. Id. The tax liability after adjusting for the failure to place the property in service did not differ from the tax liability after adjusting for the valuation overstatements. Id. Any alleged valuation overstatement, moreover, was irrelevant, because the property that was the subject of the alleged overvaluation misstatement was never placed in service during the relevant tax year. Id. The Fifth Circuit, therefore, held that the tax underpayment could not be attributed to the valuation overstatement. Id.
Gainer involved the same fact pattern as Todd. 893 F.2d at 226. Like the Fifth Circuit, the Ninth Circuit declined to impose valuation overstatement penalties where the IRS separately disallowed depreciation deductions and credits because the property at issue was not placed in service during the relevant tax year. Id. at 228. Because a valid, independent basis for disallowing the deductions and credits еxisted, the court concluded that
The Court of Federal Claims concluded that this case is analogous to those in the Todd and Gainer category because, in its view, the “adjustments were made on grounds unrelated to valuation . . . .” Penalty Op. at 15. The trial court disregarded that a valid, independent basis for the adjustments existed in those cases. The only grounds on which the partnerships conceded the adjustments in this case was the inapplicable
Even if factually identical to this case, moreover, we are not persuaded that Todd, Gainer, and their progeny accurately apply the valuation misstatement penalty. Indeed, the flaws in the analysis employed in Todd and Gainer are so apparent that subsequent panels of the circuit courts deciding those cases have questioned their holdings.
In Todd, the Fifth Circuit looked to guidance from the “Blue Book,” a post-enactment summary of the legislation prepared by the staff of the Joint Committee on Taxation, to determine whether the tax underpayment at issue was attributable to a valuation misstatement. 862 F.2d at 542-43 (interpreting Staff of the Joint Committee on Taxation, General Explanation of the Economic Recovery Tax Act of 1981, at 333 (Comm. Print 1981) (“Blue Book“)). The Blue Book proposed applying the following analytical rule: “The portion of a tax underpayment that is attributable to a valuation overstatement will be determined after taking into account any other proper adjustments to tax liability . . . .” Id. (quoting Blue Book at 333). The Blue Book then proposed a formula for applying that rule: The tax underpayment attributable to the valuation overstatement equals the difference between (i) “actual tax liability (i.e., the tax liability that results from a proper valuation and which takes into account any other proper adjustments““; and (ii) “actual tax liability as reduced by taking into account the valuation overstatement.” Id. (quoting Blue Book at 333). The Blue Book then provided an example of the application of that rule: If an improper $20,000 deduction “was claimed by the taxpayer as a result of a valuation misstatement,”
The Blue Book, in sum, offers the unremarkable proposition that, when the IRS disallows two different deductions, but only one disallowance is based on a valuation misstatement, the valuation misstatement penalty should apply only to the deduction taken on the valuation misstatement, not the other deduction, which is unrelated to valuation misstatement.
The court in Todd mistakenly applied that simple rule to a situation in which the same deduction is disallowed based on both valuation misstatement- and non-valuation-misstatement theories. There, the IRS disallowed the claimed deduction because the property was not placed in service during the relevant tax year and was overvalued. Id. at 543. Because placing the property in service was a prerequisite for taking the deduction, the court believed that any alleged overvaluation of the same property was irrelevant where the property never met the prerequisite in the first instance. Id.
The Blue Book does not describe or apply to the scenario presented in Todd, however. The Fifth Circuit recognized this flaw in a recent case in a concurring opinion joined by the entire panel. See Bemont Invs., LLC v. United States, No. 10-41132, slip op. at 20 (5th Cir. April 26, 2012) (Prado, J., concurring, joined by Reavley and Davis, JJ.) While the panel in Bemont Investments was obligated to affirm a district court decision denying a valuation misstatement penalty on the basis of Todd, it wrote separately to express its disagreement with Todd‘s reasoning. As the concurrence correctly observed:
The Blue Book only covers the case of two unrelated deductions, one of which is caused by overvaluation. Accordingly, the Blue Book does not suggest that the overvaluation penalty should not apply if overvaluation is one of two possible grounds for denying the same deduction and the ground explicitly chosen is not overvaluation.
Id. at 22. The court in Bemont Investments further observed that every circuit court to have addressed the issue, except the Ninth Circuit in Gainer, has rejected Todd‘s reasoning. Id. at 24-25 (citing Fid. Int‘l Currency Advisor A Fund, LLC v. United States, 661 F.3d 667, 673-74 (1st Cir. 2011); Merino, 196 F.3d at 158; Zfass v. Comm‘r, 118 F.3d 184, 191 (4th Cir. 1997); Illes v. Comm‘r, 982 F.2d 163, 167 (6th Cir. 1992); Gilman v. Comm‘r, 933 F.2d 143, 151 (2d Cir. 1991); Massengill v. Comm‘r, 876 F.2d 616, 619-20 (8th Cir. 1989)). Even the Ninth Circuit has recognized that Gainer might have been incorrectly decided. Keller v. Comm‘r, 556 F.3d 1056, 1060-61 (9th Cir. 2009) (holding that the Ninth Circuit is “constrained by” Gainer, which “rested in large part” on Todd, but recognizing the “sensible method” of “many other circuits“). We, too, part with the Todd and Gainer panels.
We agree that an underpayment of tax may be attributable to a valuation misstatement for purposes of the statute even when the IRS asserts both a valuation-misstatement ground and a non-valuation-misstatement
The Court of Federal Claims erred both by adopting the legal analysis applied in Todd and Gainer and by expanding that flawed analysis even beyond the facts presented there. On remand, the trial court must determine whether the taxpayers’ underpayments are attrib
IV
Finally, the taxpayers appeal the Court of Federal Claims‘s grant of summary judgment to the government on the twenty-percent penalty for negligence, substantial understatement, and failure to act reasonably and in good faith. The taxpayers’ appeal is premature. If the Court of Federal Claims concludes on remand that the forty-percent gross valuation misstatement penalty applies, the taxpayers’ cross appeal of the twenty-percent penalty potentially will be moot. Even if the trial court were to find that both penalties apply, it would be permitted to impose only the highest of those because the gross valuation misstatement penalty and accuracy-related penalty may not be stacked. See
If the Court of Federal Claims were to impose the forty-percent penalty, and this court were to affirm that penalty, arguments regarding the propriety of the twenty-percent penalty would be moot. This court would not be
V
We reverse the Court of Federal Claims‘s holding that it lacked jurisdiction to determine the identity of RRMC Group‘s partners. We also vacate its holding that the gross valuation penalty is inapplicable. Finally, we dismiss the taxpayers’ appeal of the negligence penalty as premature, without prejudice to reassertion of the arguments relating to that appeal if and when appropriate. This action is remanded to the trial court for further proceedings consistent with this opinion.
REVERSED IN PART, DISMISSED IN PART, and REMANDED