T.C. Memo. 2018-191
UNITED STATES TAX COURT
ESTATE OF JAMES P. KEETER, DECEASED, GARRY L. HOLTON, JR., AND THOMAS W. SCHAEFER, CO-EXECUTORS, AND JULIE KEETER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 6771-16. Filed November 15, 2018.
N. Jerold Cohen and Rebecca M. Stork, for petitioners.
Gerald A. Thorpe, for respondent.
MEMORANDUM OPINION
GOEKE, Judge: Pending before the Court is petitioners’ motion to restrain
the assessment or the collection of tax or to order the refund of the amount -2-
[*2] collected.1 This case is based on affected item notices of deficiency issued to
James and Julie Keeter following the completion of a partnership-level proceeding
under the unified audit and litigation partnership procedures (TEFRA). Petitioners
argue that the notices of deficiency are invalid and the Court lacks jurisdiction.2
Respondent argues that the notices are valid and acquiesces to petitioners’ motion
to restrain the assessment and the collection of tax if the Court determines that the
notices are valid. We find the notices are valid, and we will grant petitioners’
motion to restrain the assessment and collection of tax.
The validity of the notices of deficiency depends on whether a partner-level
determination is required following the decision in the TEFRA case. Petitioners
argue that no partner-level determination is required because the partnership was a
sham, and a partner’s outside basis in a sham partnership cannot exceed zero.
Respondent agrees that a partner’s outside basis in a sham partnership is zero.
However, he contends that a partner-level determination is required where the
1 Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) in effect for the years at issue. All amounts are rounded to the nearest dollar. 2 Petitioners argue that if we find the notices invalid, we nevertheless have jurisdiction to enjoin the assessment and the collection of tax. Respondent argues that we lack jurisdiction if the notices are invalid. As we find the notices valid, we do not address petitioners’ argument. -3-
[*3] partners have claimed loss deductions on the sale of assets received in a
liquidating distribution from the sham partnership as petitioners have in this case.
Accordingly, he argues that the deficiency procedures apply, the notices of
deficiency are valid, and we have jurisdiction over the deficiencies and the
authority to enjoin the assessment and the collection of tax. We hold that the
notices are valid and we have jurisdiction over this case.
Background
The background facts are based on the pleadings and attached exhibits, the
parties’ filings with respect to petitioners’ motion, including respondent’s
objection, the parties’ supporting memoranda and attached exhibits, and other
material in the Court’s record. The parties’ written statements of fact to the Court
have not been disputed.
Petitioners are a widow and her deceased husband’s estate. Julie Keeter
resided in Florida at the time of the petition’s filing. The estate had a mailing
address in Georgia. The record does not indicate either executor’s State of
residence. In the petition, petitioners state that the estate’s legal residence is in
Georgia.
James and Julie Keeter filed joint tax returns for 1999 through 2003.
During 1999 the Keeters engaged in a tax shelter transaction referred to as the -4-
[*4] Bond Linked Issue Premium Structure (BLIPS) through Sanford Strategic
Investment Fund, LLC (Sanford), a partnership for Federal tax purposes. The
objective of the tax shelter was to inflate the tax shelter investor’s outside basis in
a partnership to generate a tax loss on the partner’s subsequent sale of property
received in a liquidating distribution from the partnership.
Under the BLIPS tax shelter the investor would organize a single-member
limited liability company (LLC) that would obtain a premium loan consisting of a
principal amount and a substantial additional premium with an above-market
interest rate. Shasta Strategic Inv. Fund, LLC v. United States (Shasta Strategic),
No. C-04-04264-RS, 2014 WL 3852416, at *2 (N.D. Cal. July 31, 2014). The
premium amount of the loan was set to equal the investor’s desired tax loss. Id.
The investor also made a capital contribution to the LLC of approximately 7% of
the premium. Id. The LLC would contribute all the funds to an investment fund,
also organized as an LLC (second LLC), and the second LLC would assume the
liability to repay the loan. Id. at *3. For purposes of calculating the investor’s
outside basis in the second LLC, the investor would treat the obligation to repay
the premium portion of the loan as contingent and not as a liability assumed by the
LLC under section 752. Id. As a result the investor calculated his outside basis as
equal to the premium plus his capital contribution, resulting in an inflated outside -5-
[*5] basis. Id.; see secs. 722 (providing that a partner’s outside basis in a partner
interest acquired by a contribution of property equals the contributing partner’s
adjusted basis in the property plus any gain recognized to the contributing partner
under section 721(b)), 733 (providing that a partner’s outside basis increases for
capital contributions to the partnership and decreases for the partner’s liabilities
assumed by the partnership). The second LLC would purchase foreign currency
assets. After a brief time, typically 60 days, the investor would exit the BLIPS tax
shelter. For the investors to obtain the tax shelter benefits, the LLC would
terminate; it would sell certain assets, repay the loan, and distribute a small
amount of foreign currency and stock to the investor. The investor would claim
inflated bases in the distributed assets on the basis of his inflated basis in the LLC,
generating tax losses on the investor’s sales of the distributed assets.
As part of the tax shelter the Keeters received a liquidating distribution of
marketable securities (stock) and foreign currency during 1999 from Sanford. The
Keeters treated the distributed assets as having adjusted bases in their hands equal
to their outside basis in Sanford pursuant to section 732(b). That same year they
sold the stock and a portion of the foreign currency. They sold the remainder of
the currency during 2000 through 2002. For 1999 the Keeters claimed a capital
loss deduction on the sale of the stock and an ordinary loss deduction on the sale -6-
[*6] of the foreign currency; for 2000 through 2002 they claimed ordinary loss
deductions on the sales of the currency. The losses were generated upon the sales
of the distributed assets as a result of the Keeters’ inflated outside basis in
Sanford.3
On July 23, 2004, respondent issued a notice of deficiency for 1999 through
2001 to the Keeters (2004 notice) for tax deficiencies arising from the tax shelter.
In response to the 2004 notice the Keeters made payments to the Internal Revenue
Service (IRS) for 1999 and 2000 in excess of $16 million. The IRS also applied
an overpayment from 2006 of approximately $3.2 million for 2001. Subsequently,
respondent determined that he had issued the 2004 notice in error because the
TEFRA partnership-level proceeding had not been resolved and notified the
Keeters of the error in November 2007. In February 2008 the Keeters filed a
refund claim for the payments and credit. The IRS denied the refund claim on the
basis that the amounts were advance payments and not overpayments of tax.
On July 19, 2004, respondent issued a notice of final partnership
administrative adjustment (FPAA) for Sanford’s December 22, 1999, tax period.
In the FPAA he determined that Sanford was a sham and disregarded for tax
purposes, the BLIPS transaction lacked economic substance, and the Keeters
3 The Keeters are partners in Sanford as defined in sec. 6231(a)(2)(B). -7-
[*7] engaged in the transaction for tax-avoidance purposes. The tax matters
partner filed a complaint in the District Court for the Northern District of
California seeking a readjustment of the partnership items in the FPAA. Sanford
Strategic Inv. Fund, LLC v. United States, No. C-04-04398-RS (N.D. Cal. filed
Oct. 18, 2004). The case was consolidated for trial with other cases involving
BLIPS tax shelters. The District Court granted summary judgment for the
Government. Shasta Strategic, 2014 WL 3852416, at *1. The District Court
examined the economic substance of the BLIPS transactions and held that they
lacked economic substance and should be disregarded for Federal tax purposes.
Id. at *5-*9. The District Court did not specifically address whether the LLCs
were shams. On January 20, 2015, the District Court entered its final judgment for
the Government with respect to all adjustments to partnership items in the FPAA
except for one issue not relevant here. Sanford Strategic Inv. Fund, LLC, No. C-
04-04398-RS (N.D. Cal. Jan. 20, 2015).
On December 18, 2015, respondent issued a notice of deficiency to James
and Julie Keeter for each year from 1999 through 2003 relating to affected items
attributable to the TEFRA partnership proceeding. He disallowed the capital and
ordinary loss deductions that the Keeters claimed arising from the sales of the
stock and currency, respectively, and determined that the Keeters realized capital -8-
[*8] gain and ordinary income on the sales, respectively. He also made
adjustments to other items, including itemized deductions and exemptions, on the
basis of the increase in the Keeters’ adjusted gross income resulting from the
disallowance of the loss deductions. In the notices respondent determined that the
Keeters had adjusted bases in the stock and the foreign currency greater than zero.
On that same date respondent issued notices of computational adjustment
for 1999 and 2000 for adjustments attributable to the TEFRA proceeding that
respondent determined did not require partner-level determinations. The
adjustments in the notices of computational adjustment are separate from the
adjustments determined in the notices of deficiency for 1999 and 2000 and relate
to adjustments of the Keeters’ distributive share of the income, loss, or deduction
from Sanford. On March 17, 2016, respondent assessed the deficiencies asserted
in the affected item notices as a protective measure. In their petition, petitioners
raised an issue relating to the application of the Keeters’ advance payments and
the 2006 overpayment to their tax liabilities.
The issue for consideration is whether the adjustments in the notices of
deficiency attributable to the TEFRA decision require a partner-level
determination and thus give us jurisdiction over this case. We hold that they do -9-
[*9] and that we have jurisdiction. Accordingly, we have jurisdiction to enjoin the
assessment and the collection of tax, and we grant petitioners’ motion.
Discussion
Section 6213(a) provides that the Commissioner is generally prohibited
from assessing and collecting tax without first issuing a notice of deficiency. The
prohibition on assessment extends during the time a petition may be filed in this
Court, during the pendency of any proceeding actually brought, and until the
decision of the Court becomes final. Sec. 6213(a). The Court has jurisdiction to
enjoin the assessment and the collection of a tax deficiency that the Court has
jurisdiction to redetermine. Sec. 6213(a); see Meyer v. Commissioner, 97 T.C.
555, 560-561 (1991). We have jurisdiction to redetermine a deficiency if the
Commissioner issues a valid notice of deficiency and the taxpayer files a timely
petition. Sec. 6214(a); GAF Corp. & Subs. v. Commissioner, 114 T.C. 519, 521
(2000). We must first determine whether the notices of deficiency are valid and
we have jurisdiction over the tax deficiencies before we can enjoin the assessment
or the collection of tax.
As a general rule, partnerships do not pay tax, and items of partnership
income, loss, deduction, and credit are reflected on the partners’ individual tax
returns. See sec. 701. The TEFRA audit and litigation procedures under sections - 10 -
[*10] 6221 through 6234 apply to partnership items. Adjustments to partnership
items from a TEFRA partnership-level proceeding may result in adjustments to the
tax liability of the individual partners. Once the partnership items become final,
the Commissioner generally must initiate further action at the partner level to
adjust an individual partner’s tax liability. An affected item is “any item to the
extent such item is affected by a partnership item.” Sec. 6231(a)(5).
There are two types of affected items: one that does not require a partner-
level determination and one that does. Where the adjustment to the affected item
does not require a partner-level determination (computational adjustment), the
adjustment is not subject to the deficiency procedures under sections 6211 through
6216. A “computational adjustment” is the change in the partner’s tax liability to
properly reflect the treatment of a partnership item under TEFRA. Sec.
6231(a)(6). The Commissioner may immediately assess the resulting tax
deficiency from the computational adjustment against the partner without issuing a
notice of deficiency. Sec. 6230(a)(1) and (2)(A)(i); sec. 301.6231(a)(5)-1(b),
Proced. & Admin. Regs. In such case the partner does not have access to a
prepayment forum to challenge the computational adjustment and must file a
refund claim. See sec. 6230(a)(1), (c)(4). For an adjustment that does not require
a partner-level determination, a notice of deficiency would be invalid to the extent - 11 -
[*11] it pertains to that adjustment. Conversely, an adjustment to an affected item
that requires a partner-level determination is subject to the deficiency procedures,
and the Commissioner must issue a notice of deficiency to the partner before
assessing the tax. Sec. 6230(a); sec. 301.6231(a)(6)-1(a)(3), Proced. & Admin.
Regs. When an adjustment to an affected item requires a partner-level
determination, the partner has a prepayment forum to challenge the
Commissioner’s determination. Sec. 6230(a)(2)(A).
A notice of deficiency is valid if a partner-level determination is required
before the Commissioner may assess the resulting tax deficiency. Sec.
6230(a)(2)(A)(i). Both parties agree that the TEFRA partnership-level case
effectively determined that Sanford was a sham and disregarded for Federal tax
purposes.4 Petitioners argue that no partner-level determination is required to
adjust a purported partner’s outside basis to zero in a sham partnership because a
taxpayer cannot have a basis in an asset that does not exist for tax purposes, citing
Woods v. United States, 571 U.S. 31 (2013). According to petitioners’ argument
the adjustment of outside basis to zero at the partner level following a partnership-
4 We do not address the parties’ position that the partnership-level case effectively determined that the partnership was a sham. We do not need to determine for purposes of petitioners’ motion whether the case so held as we hold that even if the partnership was a sham, a partner-level determination is required relating to the assets that Sanford formally distributed to the Keeters. - 12 -
[*12] level proceeding that finds the partnership to be a sham does not require a
partner-level determination or the issuance of a notice of deficiency before
assessment of the resulting tax. Accordingly, petitioners argue that the notices of
deficiency are invalid and we lack jurisdiction. Respondent contends that even if
outside basis is always zero for a sham partnership, partner-level determinations
are required in this case. He contends that partner-level determinations are
required relating to the assets distributed to the Keeters from Sanford. He argues
that the notices of deficiency are valid and we have jurisdiction. We agree with
respondent.
The notices of deficiency adjusted loss deductions claimed by the Keeters
on the sales of the stock and currency they received in a liquidating distribution
from Sanford. In general, when a partnership distributes an asset (other than
money) to a partner other than in liquidation, the partner’s basis in the asset equals
the partnership’s adjusted basis in the asset. Sec. 732(a). When a partnership
interest is liquidated, the partner’s basis in property (other than money) received in
a liquidating distribution from the partnership generally equals the partner’s
outside basis in the partnership. Sec. 732(b). The Keeters’ outside bases in the
stock and the foreign currency received in the liquidating distribution from
Sanford would equal their (inflated) outside basis in Sanford. See sec. 732(b). As - 13 -
[*13] Sanford was a sham, petitioners argue the Keeters’ outside basis must be
zero and there is no need for a partner-level determination.
When a partnership is a sham and disregarded for Federal tax purposes, the
activities of the partnership are deemed to be engaged in directly by the purported
partners. A disregarded partnership has no identity separate from its partners. See
6611, Ltd. v. Commissioner, T.C. Memo. 2013-49, at *61. Accordingly, there can
be no capital contributions to the purported partnership or distributions from the
purported partnership. See id. The purported partner would hold the purported
partnership’s assets directly, and his adjusted bases in the assets would be
determined under section 1012(a). See sec. 1012(a) (providing the basis of
property is generally its cost). The putative partner would not have an adjusted
basis in an asset received in a liquidating distribution that carries over from his
outside basis under section 732(b). The District Court in the partnership-level
TEFRA case held that the BLIPS transactions, including the loans and capital
contributions, lacked economic substance and were disregarded for Federal tax
purposes. Shasta Strategic, 2014 WL 3852416, at *9. Moreover, a partner’s
outside basis in his partnership interest is generally an affected item that must be
adjusted at the partner level. Sec. 6231(a)(1); see Woods, 571 U.S. at 42;
Thompson v. Commissioner, 729 F.3d 869, 873 (8th Cir. 2013), rev’g and - 14 -
[*14] remanding 137 T.C. 220 (2011); Petaluma FX Partners, LLC v.
Commissioner, 591 F.3d 649, 654-655 (D.C. Cir. 2010), aff’g in part, rev’g and
remanding in part 131 T.C. 84 (2008).
We hold that the adjustments to the loss deductions on the sales of the stock
and the foreign currency are affected items that require partner-level
determinations. Partner-level determinations are required to adjust the loss
deductions including partner-level determinations relating to the Keeters’ holding
periods of the stock and currency, the character of the gain or loss, and whether
the stock sold by the Keeters in 1999 and the foreign currency sold in 1999
through 2003 were the stock and currency distributed by Sanford.5 See Napoliello
v. Commissioner, 655 F.3d 1060 (9th Cir. 2011), aff’g T.C. Memo. 2009-104;
Domulewicz v. Commissioner, 129 T.C. 11, 20 (2007), aff’d in relevant part,
remanded in part sub nom. Desmet v. Commissioner, 581 F.3d 297 (6th Cir.
2009). Petitioners argue that in the notices of deficiency respondent did not in fact
5 In the notices of deficiency respondent also determined affected item adjustments for itemized deductions and exemptions. Although these adjustments are mathematical computations based on applicable statutory limitations, they are affected items that require partner-level determinations because they are attributable to the increase in the Keeters’ adjusted gross income from the disallowance of the loss deductions on the sales of the stock and the foreign currency that requires partner-level determinations. See sec. 301.6231(a)(5)-1(a), Proced. & Admin. Regs. - 15 -
[*15] make any determinations at the partner level. However, the deficiency
procedures apply even though the resulting partner-level determinations may not
alter the result. “Neither the Code nor the regulations * * * require that partner-
level determinations actually result in a substantive change to a determination
made at the partnership level.” Domulewicz v. Commissioner, 129 T.C. at 20.
Moreover, in the notices of deficiency respondent did not determine that the
distributed assets had adjusted bases of zero. Rather, he determined that the assets
had adjusted bases greater than zero.
As we have found that the adjustments require partner-level determinations,
the deficiency procedures apply. The notices of deficiency are valid, and we have
jurisdiction over this case. Likewise, the deficiency procedures apply to the other
affected items adjusted in the notices of deficiency, including certain adjustments
to itemized deductions based on the applicable statutory limitations period for
adjusted gross income as a result of the increases to the Keeters’ adjusted gross
income from the disallowance of the loss deductions. See sec. 301.6231(a)(5)-
1(a), Proced. & Admin. Regs.
We will grant petitioners’ motion to enjoin the assessment and the
collection of tax. We will deny as untimely that part of petitioners’ motion that
seeks a refund. We have jurisdiction to order a refund of overpayments - 16 -
[*16] determined by this Court. Sec. 6512(b); Estate of Quick v. Commissioner,
110 T.C. 440, 443 (1998); see sec. 6402(a) (granting the Secretary authority to
credit an overpayment to any tax liability). As we have not determined whether
there is an overpayment, we do not have authority to order a refund.
In reaching our holding, we have considered all arguments made, and, to the
extent not mentioned above, we conclude that they are moot, irrelevant, or without
merit.
An appropriate order will be
issued.