Petaluma FX Partners, LLC, Ronald Scott Vanderbeek, A Partner Other Than the Tax Matters Partner v. Commissioner

131 T.C. No. 9

• Court: United States Tax Court
• Decided: October 23, 2008
• Docket: 24717-05
• Status: Unknown

Opinion

131 T.C. No. 9

UNITED STATES TAX COURT

PETALUMA FX PARTNERS, LLC, RONALD SCOTT VANDERBEEK, A PARTNER OTHER THAN THE TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 24717-05. Filed October 23, 2008.

P challenges adjustments in a final partnership administrative adjustment (FPAA) issued to a partnership (PFP). P stipulated most of the adjustments in the FPAA and argues that the Court lacks jurisdiction over the remaining determinations. P stipulated that he will not contest any determinations in the FPAA over which the Court finds it has jurisdiction except for the valuation penalties, which P argues do not apply to the partnership items at issue as a matter of law. R argues that all remaining determinations in the FPAA are partnership items or are otherwise within the Court’s jurisdiction and therefore seeks summary judgment on all remaining issues.

Held: The issue of whether PFP should be disregarded for tax purposes is a partnership item.

Held, further, because we conclude that we have jurisdiction to determine that PFP should be - 2 -

disregarded for tax purposes, we may determine that the partners had no outside bases in PFP.

Held, further, the Court has jurisdiction to determine whether a valuation misstatement penalty applies.

Held, further, because P stipulated that he will not contest any determinations in the FPAA over which the Court determines it has jurisdiction and the Court finds it has jurisdiction over all determinations necessary to support the adjustments in the FPAA, we shall grant R’s motion for summary judgment and deny petitioner’s cross-motion for summary judgment.

Edward M. Robbins, Jr., for petitioner.

Gerald A Thorpe and Jason M. Kuratnick, for respondent.

OPINION

GOEKE, Judge: This case is before the Court on the parties’

cross-motions for summary judgment under Rule 121.1 The issues

for decision are: (1) Whether the Court has jurisdiction in this

partnership-level proceeding to determine whether Petaluma FX

Partners, L.L.C. (Petaluma) should be disregarded for tax

purposes; (2) whether the Court has jurisdiction to determine

whether the partners’ outside bases in Petaluma were greater than

zero; (3) whether the Court has jurisdiction to determine whether

the accuracy-related penalties determined in a notice of final

1 Unless otherwise indicated, all Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code (Code) in effect for the year at issue. - 3 -

partnership administrative adjustment (FPAA) apply; (4) if the

Court has jurisdiction to review the application of the accuracy-

related penalties determined in the FPAA, whether the substantial

valuation misstatement penalties are applicable to the

adjustments of partnership items; and (5) whether the Court has

jurisdiction to review the remaining determinations made in the

FPAA.

For the reasons discussed below, we shall grant respondent’s

motion for summary judgment and deny petitioner’s cross-motion

for summary judgment.

Background

Petaluma, a purported partnership,2 was formed in August

2000. Bricolage Capital, L.L.C.; Stillwaters, Inc.; and Caballo,

Inc., executed the operating agreement for the partnership.

Petaluma’s alleged business purpose was to engage in foreign

currency option trading on behalf of its partners. On or about

October 10, 2000, Ronald Thomas Vanderbeek (RTV) and Ronald Scott

Vanderbeek (RSV) became partners of Petaluma by contributing

pairs of offsetting long and short foreign currency options. In

computing their adjusted bases in their interests in Petaluma,

RTV and RSV increased their adjusted bases to reflect their

contributions of the long options to Petaluma but did not

2 Respondent argues that Petaluma was not a partnership for tax purposes. We use the terms “partnership”, “partner”, and related terms for convenience. - 4 -

decrease their adjusted bases to reflect Petaluma’s assumption of

the short options (or written call options) they contributed.3

RTV and RSV withdrew from Petaluma on December 12, 2000.

Petaluma distributed cash and shares of Scient stock to RTV and

RSV in liquidation of their partnership interests. Pursuant to

section 732, RTV and RSV determined the adjusted bases in their

Scient stock according to the adjusted bases in their interests

in Petaluma immediately before the distribution. RTV and RSV

sold their Scient stock on December 26, 2000, and claimed losses

on their 2000 Federal income tax returns of about $17,776,360 and

$7,631,542, respectively. At the time of the filing of the

petition, Petaluma had no principal place of business and was

engaged in no business.

On April 2, 2001, Petaluma timely filed its Form 1065, U.S.

Return of Partnership Income, for the taxable year ending

December 31, 2000.

On July 28, 2005, respondent issued an FPAA to the tax

matters partner and the notice partners of Petaluma. On August

30, 2005, respondent issued a second FPAA to correct an error

regarding the taxable year to which the FPAA related. See

Petaluma FX Partners, LLC v. Commissioner, T.C. Memo. 2007-254.

With exceptions not relevant here, the adjustments made in the

3 Respondent does not dispute that RTV and RSV actually paid the net premiums for these options. - 5 -

August 30, 2005, FPAA were identical to the adjustments made in

the July 28, 2005, FPAA.4 According to our holding in T.C. Memo.

2007-254, the FPAA issued on July 28, 2005, suffices to vest this

Court with jurisdiction for Petaluma’s tax year ending December

31, 2000. Further references herein to the FPAA are to the FPAA

issued on July 28, 2005.

In the FPAA, respondent made the following adjustments:

Item As Reported As Corrected Capital contributions $478,800 -0- Distributions--property 171,806 -0- other than money Outside partnership 24,943,505 -0- basis Distributions--money 206,076 -0- Other income 107,242 -0- Tax-exempt interest 547 -0- income Assets--cash 171,939 -0- Liabilities and 6,158 -0- capital--other current liabilities Partners’ capital 165,781 -0- accounts

4 The corrected FPAA omitted adjustments to liabilities and capital and assets/cash. Petitioner concedes that respondent’s adjustments to these items are correct; therefore, our analysis is the same regardless of which FPAA serves as the basis for our jurisdiction. - 6 -

The FPAA also included the following statement:

Outside partnership basis and the penalties are determined at the partnership level. The penalty will be imposed on the partner level. The applicable penalty sections are IRC 6662(a), 6662(b)(1), 6662(b)(2), 6662(b)(3), 6662(c), 6662(d), 6662(e) and 6662(h).

In addition, respondent made a number of determinations regarding

Petaluma and its partners under the title of “EXHIBIT A--

Explanation of Items” (the explanation of items). The

explanation of items is attached hereto as an appendix. The

explanation of items essentially provides the following

explanations for the adjustments to Petaluma’s partnership items:

(1) Petaluma was not a partnership as a matter of fact; (2) even

if Petaluma did exist as a partnership, it had no business

purpose other than tax avoidance, lacked economic substance,

constituted an economic sham, and was abusive under section

1.701-2, Income Tax Regs.; therefore, the transactions Petaluma

entered into should be treated as having been entered into

directly by the partners; and (3) neither Petaluma nor its

partners entered into the options positions or purchased the

foreign currency or stock with a profit motive for purposes of

section 165(c)(2). The explanation of items also provides

several alternative reasons for reducing the partners’ adjusted

bases in Petaluma and determines that penalties under section

6662 are applicable. On December 30, 2005, RSV, as a partner - 7 -

other than the tax matters partner of Petaluma, filed a petition

seeking review of the adjustments set forth in the FPAA.

On May 22, 2007, the parties filed a stipulation of settled

issues (stipulation). Petitioner stipulated that the following

partnership items should be adjusted according to the FPAA:

Other income, tax-exempt interest income, distributions--money,

distributions–-property other than money, capital contributions,

assets-–cash, liabilities and capital-–other current liabilities,

and partner’s capital accounts. Petitioner further stipulated

that his position is that the Court lacks jurisdiction to

consider the remaining issues raised in the FPAA, which include

the partners’ aggregate adjusted basis in the partnership (or

outside basis) and the determinations in the explanation of

items, including the penalties. However, petitioner also

stipulated that he would not contest any issues raised by the

FPAA over which the Court has jurisdiction except for the issue

of whether the valuation misstatement penalties apply.

Respondent filed a motion for summary judgment asserting

that the Court has jurisdiction over the remaining issues raised

by the FPAA because they all relate to partnership items and that

a decision should be entered in favor of respondent on the

remaining issues.

Petitioner filed a cross-motion for summary judgment arguing

that he has stipulated all of the partnership items adjusted in - 8 -

the FPAA and is entitled to summary judgment because all of the

remaining issues relate to nonpartnership items over which the

Court lacks jurisdiction under section 6226(f).5 In the

alternative, petitioner argues that the valuation misstatement

penalties imposed under section 6662(a), (b)(3), (e), and (h) are

inapplicable as a matter of law because the penalties do not

relate to an error in “valuation” but relate to respondent’s

determination that Petaluma and/or the transactions it

purportedly entered into should be disregarded.

Discussion

Summary judgment is intended to expedite litigation and

avoid unnecessary and expensive trials. Fla. Peach Corp. v.

Commissioner, 90 T.C. 678, 681 (1988). Summary judgment may be

granted where there is no genuine issue of any material fact and

a decision may be rendered as a matter of law. Rule 121(a) and

(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992),

affd. 17 F.3d 965 (7th Cir. 1994).

The parties agree that this case is ripe for summary

judgment because both parties raise only questions of law.

Petitioner stipulated: “if the Court determines that it has

jurisdiction in this case, petitioner does not intend to contest

5 Petitioner did not file a motion for dismissal because sec. 6226(h) provides that a “decision of the court dismissing the action shall be considered as its decision that the notice of final partnership administrative adjustment is correct”. - 9 -

any of the issues raised in the FPAA other than the issue of

whether the valuation misstatement penalty would apply in this

case”. When a party explicitly states that he does not intend to

contest an issue, we have found it appropriate to deem the issue

conceded and not require the other party to prove the issue

affirmatively. Tan Xuan Bui v. Commissioner, T.C. Memo. 2007-

104; DeCaprio v. Commissioner, T.C. Memo. 1996-367. Furthermore,

stipulations are treated as conclusive and binding admissions by

the parties unless otherwise permitted by the Court. Rule 91(e);

Stamos v. Commissioner, 87 T.C. 1451, 1454-1455 (1986).

Accordingly, with the exception of the determinations of the

valuation penalties, if we find that we have jurisdiction over a

determination made in the FPAA, we shall treat the issue as

conceded by petitioner, grant respondent’s motion for summary

judgment on the issue, and deny petitioner’s cross-motion for

summary judgment on the issue.

Petitioner’s primary argument is that all of the adjustments

and determinations in the FPAA that petitioner has not conceded

are adjustments to the partners’ outside bases or are otherwise

nonpartnership items that are outside the Court’s jurisdiction

under section 6226(f). Specifically, petitioner argues that the

determinations that Petaluma should be disregarded for tax

purposes, that the partners’ aggregate outside partnership basis

is zero, and that the penalties apply are either nonpartnership - 10 -

items or not “items” at all. In the alternative, petitioner

argues that valuation misstatement penalties are not applicable

here.

I. TEFRA Procedures and Partnership Items

Partnerships do not pay Federal income taxes, but they are

required to file annual information returns reporting the

partners’ distributive shares of tax items. Secs. 701, 6031.

The individual partners then report their distributive shares of

the tax items on their Federal income tax returns. Secs. 701-

704.

To remove the substantial administrative burden occasioned

by duplicative audits and litigation and to provide consistent

treatment of partnership tax items among partners in the same

partnership, Congress enacted the unified audit and litigation

procedures of the Tax Equity and Fiscal Responsibility Act of

1982 (TEFRA), Pub. L. 97-248, sec. 401, 96 Stat. 648. See

Randell v. United States, 64 F.3d 101, 103 (2d Cir. 1995); H.

Conf. Rept. 97-760, at 599-600 (1982), 1982-2 C.B. 600, 662-663.

Under TEFRA, all partnership items are determined in a

single partnership-level proceeding. Sec. 6226; see also Randell

v. United States, supra at 103. The determination of partnership

items in a partnership-level proceeding is binding on the

partners and may not be challenged in a subsequent partner-level

proceeding. See secs. 6230(c)(4), 7422(h). This prevents the - 11 -

courts from relitigating the same issues with each of the

partners.

After the final partnership-level adjustments have been

made, further partner-level actions may be taken to bring the

partners’ returns into conformity with the determinations made at

the partnership level or to address issues that are specific to

the partners. If a computational adjustment can be made without

making any additional partner-level determinations, the

Commissioner directly assesses the changes in the partner’s tax

liability as a computational adjustment without issuing a notice

of deficiency. Sec. 6231(a)(6), (c); N.C.F. Energy Partners v.

Commissioner, 89 T.C. 741, 744 (1987); sec. 301.6231(a)(6)-1T(a),

Temporary Proced. & Admin. Regs., 64 Fed. Reg. 3840 (Jan. 26,

1999). If the partner believes that the computational adjustment

was erroneous, he may bring a claim for refund after payment.

Sec. 6230(c). If a partner has an increased liability stemming

from an affected item or a computational adjustment that requires

a factual determination at the partner level, the normal

deficiency procedures outlined in sections 6212 and 6213 apply.

Sec. 6230(a); sec. 301.6231(a)(6)-1T(a)(2), Temporary Proced. &

Admin. Regs., supra.

In partnership-level proceedings such as the case before us,

the Court’s jurisdiction is limited by section 6226(f):

SEC. 6226(f). Scope of Judicial Review.--A court with which a petition is filed in accordance with this - 12 -

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. [Emphasis added.]

Section 6231(a) defines the terms “partnership item”,

“nonpartnership item”, and “affected item”:

(3) Partnership item.--The term “partnership item” means, with respect to a partnership, 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 this subtitle, such item is more appropriately determined at the partnership level than at the partner level. (4) Nonpartnership item.--The term “nonpartnership item” means an item which is (or is treated as) not a partnership item.

(5) Affected item.--The term “affected item” means any item to the extent such item is affected by a partnership item.

An “affected item” is by definition not a “partnership item”.

Ginsburg v. Commissioner, 127 T.C. 75, 79 (2006); see also Dial

USA, Inc. v. Commissioner, 95 T.C. 1, 5 (1990).

II. The Explanation of Items

Petitioner argues that the Court lacks jurisdiction over all

of the determinations in the explanation of items. Petitioner

argues that if the Court affirms the various alternative

arguments in the explanation of items, this will amount to an

advisory opinion because petitioner has stipulated all of the - 13 -

adjustments to partnership items. See Greene-Thapedi v.

Commissioner, 126 T.C. 1, 13 (2006); LTV Corp. v. Commissioner,

64 T.C. 589 (1975).

However, partnership items also affect affected items, which

are by definition nonpartnership items and therefore would not be

redetermined by the Court in this partnership-level proceeding.

See Ginsburg v. Commissioner, supra at 79; Dial USA, Inc. v.

Commissioner, supra at 5; sec. 301.6231(a)(3)-1, Proced. & Admin.

Regs.; sec. 301.6231(a)(5)-1T, Temporary Proced. & Admin. Regs.,

52 Fed. Reg. 6790 (Mar. 5, 1987). Because partnership items

include not only the figures reported on a partnership’s return

but also determinations that may affect nonpartnership items, it

is essential to determine all partnership items at the

partnership level.

III. Whether Petaluma and Its Transactions Should Be Disregarded for Tax Purposes

The first determination in the explanation of items is that

Petaluma was not a partnership in fact. The second and third

determinations in the explanation of items are to the effect that

if Petaluma was otherwise a partnership, it had no business

constituted an economic sham for Federal income tax purposes, and

was abusive under section 1.701-2, Income Tax Regs. As a

consequence, the FPAA determines that Petaluma and all of the

transactions it purportedly engaged in should be disregarded and - 14 -

that the transactions that Petaluma engaged in should be treated

as having been engaged in directly by the partners. Because all

of these determinations have the same consequence, that Petaluma

should be disregarded for tax purposes, we address them together.

Section 6233 provides that if a partnership return is filed

for a year but it is determined that no partnership exists, the

subchapter that governs the procedure for taxing partnership

items still applies to the extent provided in the regulations.

The regulations provide that the TEFRA provisions will generally

continue to apply if a purported partnership files a partnership

return. Sec. 301.6233-1T(a), Temporary Proced. & Admin. Regs.,

52 Fed. Reg. 6795 (Mar. 5, 1987). The regulations further

provide that in a partnership-level proceeding the Court may

determine whether a “partnership” existed during the year. Id.

Therefore, because Petaluma filed a partnership return for 2000,

under section 6233 and the regulations promulgated thereunder the

Court has jurisdiction to determine whether to recognize Petaluma

as a partnership for tax purposes. See also Andantech L.L.C. v.

Commissioner, 331 F.3d 972, 980-981 (D.C. Cir. 2003), affg. in

part and remanding in part T.C. Memo. 2002-97.

Furthermore, the determination of whether a partnership

should be disregarded for tax purposes under a legal doctrine

such as sham or economic substance is a partnership item.

Petitioner argues that the issue of whether Petaluma should be - 15 -

disregarded for tax purposes as a sham or for lack of economic

substance is not a partnership item because: (1) It is not an

“item”, (2) it is not a determination Petaluma was required to

make under subtitle A, and (3) the regulations do not list the

question of whether a partnership should be disregarded for tax

purposes under one of these doctrines as a partnership item.

A. Whether a Determination Must Be an “Item”

Petitioner argues that when used in the Code in connection

with defining tax consequences of various transactions, the term

“item” means an item of income, deduction, credit, gain, loss, or

basis, or a similar accounting entry. Under petitioner’s theory,

the determinations made in the explanation of items are not

“items” themselves but merely explanations of the numerical

adjustments made in the FPAA.

In RJT Inv. X v. Commissioner, 491 F.3d 732, 735 (8th Cir.

2007), the Court of Appeals reasoned that a “partnership item” is

defined as: (1) Any item required to be taken into account for

the partnership’s taxable year under a provision of subtitle A,

(2) to the extent the regulations prescribe that the item is more

appropriately determined at the partnership level. The court

concluded that determinations based on judicial doctrines such as

sham may be partnership items. Id. at 735-738; see also

Andantech L.L.C. v. Commissioner, supra at 980-982 (affirming

this Court’s decision in a partnership-level proceeding that the - 16 -

partnership should be disregarded for tax purposes). We agree

that partnership items may include determinations of whether a

partnership should be disregarded for tax purposes as a sham or

for lack of economic substance. Therefore we disagree that the

term “partnership item” is defined in the narrow sense that

petitioner advocates.

B. Whether the Determination To Disregard Petaluma Is Required To Be Taken Into Account for Petaluma’s Taxable Year Under a Provision of Subtitle A

Petitioner argues that judicial doctrines such as sham or

lack of economic substance that address the validity of a

partnership are not found in subtitle A, in any part of the Code

related to partnerships, or on Form 1065; therefore, a

determination that Petaluma is a sham and/or lacks economic

substance cannot be a partnership item under section 6231(a)(3).

Respondent argues that the definition of a “partnership

item” is not so limited. Respondent argues that if a partnership

is a sham, lacks economic substance, or was formed for tax

avoidance purposes, the partnership and/or its transactions are

disregarded for tax purposes. See Andantech L.L.C. v.

Commissioner, T.C. Memo. 2002-97. Consequently, the amount of

the partnership’s income, credit, gain, loss, deduction, and

similar items would be reduced to zero, and these items are

required to be taken into account under subtitle A. - 17 -

While petitioner has stipulated or will not contest most of

the adjustments in the FPAA, this does not affect the need to

determine whether Petaluma was a sham or lacked economic

substance in order to properly account for various tax items

under subtitle A. Petitioner may not eliminate our jurisdiction

over the determinations in the explanation of items by conceding

the adjustments to one or more of the partnership items. See LTV

Corp. v. Commissioner, 64 T.C. at 591. Furthermore, as discussed

above, a determination whether Petaluma was a valid partnership

is not mooted by petitioner’s stipulations because a

determination of whether Petaluma was a valid partnership may

also affect any number of affected items.

RJT Inv. X v. Commissioner, supra, supports respondent’s

position that the determination of whether a partnership should

be disregarded for tax purposes is a partnership item. The court

reasoned that the validity of a partnership–-in particular, its

status as a sham--is a matter that is required to be taken into

account under subtitle A because it directly affects many of the

components of the partnership’s and partners’ tax reporting:

When filling out individual tax returns, the very process of calculating an outside basis, reporting a sales price, and claiming a capital loss following a partnership liquidation presupposes that the partnership was valid.

Id. at 736. Therefore, because the validity of a partnership

affects tax items that are required to be taken into account - 18 -

under subtitle A, the validity of a partnership is also a

determination the partnership is required to make.

Petitioner argues that RJT Investments X is distinguishable

because in RJT Investments X the record included comprehensive

facts sufficient for the court to conclude, as a matter of fact,

that the partnership was a sham. Petitioner argues that the

court’s treatment of that matter as a partnership item was merely

dictum rather than a holding because the factual findings were

sufficient to eliminate the partners’ outside bases.

Petitioner is incorrect. As in this case, the taxpayers in

RJT Investments X raised only jurisdictional arguments on appeal

and were deemed to have waived any challenges to the sufficiency

of the evidence. Id. at 735, 738 n.9. The legal issue in RJT

Investments X is the same question that we must decide, and we

are persuaded by the decision of the Court of Appeals.

Petitioner also argues that the explanation of items

contains various alternative arguments and nothing in subtitle A

requires a partnership to affirmatively rebut the myriad

potential arguments that the Commissioner might use to attack the

validity of a partnership and its transactions. However,

petitioner points to no authority, and we know of none, that

prohibits an FPAA from asserting alternative arguments for

adjusting partnership items. - 19 -

For the reasons provided in RJT Investments X, we agree with

respondent that whether Petaluma is a sham, lacks economic

substance, or otherwise should be disregarded for tax purposes is

required to be taken into account under subtitle A. Therefore

this requirement is satisfied.

C. Whether the Regulations Prescribe That the Item Is More Appropriately Determined at the Partnership Level

Section 301.6231(a)(3)-1(a), Proced. & Admin. Regs., lists a

number of items that constitute “partnership items” but does not

explicitly list judicial concepts such as “sham” or “economic

substance”. However, section 301.6231(a)(3)-1(b), Proced. &

Admin. Regs., provides that 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.” Because the determination of whether a

partnership is a sham or lacks economic substance underlies all

of the purported partnership’s tax items, it fits squarely within

the regulation. See Gregory v. Helvering, 293 U.S. 465 (1935);

Andantech L.L.C. v. Commissioner, T.C. Memo. 2002-97.

Petitioner argues that notwithstanding section

301.6231(a)(3)-1(b), Proced. & Admin. Regs., the validity of

Petaluma is more appropriately determined at the partner level

because the decision of whether a partnership should be respected - 20 -

for tax purposes is based on the totality of the facts and

circumstances surrounding the transaction. See Falsetti v.

Commissioner, 85 T.C. 332, 348 (1985); Salina Pship. L.P. v.

Commissioner, T.C. Memo. 2000-352. Petitioner emphasizes that

whether economic substance or related judicial doctrines should

apply “involves an intensely factual inquiry.” Andantech L.L.C.

v. Commissioner, T.C. Memo. 2002-97; see also Harris v.

Commissioner, 61 T.C. 770, 783 (1974). Therefore, petitioner

argues that because the “totality of the facts and circumstances”

necessarily includes some facts not available at the partnership

level, a determination of sham or lack of economic substance

cannot be a partnership item. In particular, petitioner argues

that the determination of whether a partnership is recognized for

substantive tax law purposes depends in part on the intent of the

partners. See Andantech L.L.C. v. Commissioner, 331 F.3d at 978.

Petitioner argues that any determination that requires a partner-

level analysis is a nonpartnership item. See N.C.F. Energy

Partners v. Commissioner, 89 T.C. at 744; Allen Family Foods,

Inc. v. Commissioner, T.C. Memo. 2000-327. Therefore, petitioner

argues that if the Court decides that the validity of Petaluma is

an “item”, it must be an affected item.

We first note that Andantech L.L.C. v. Commissioner, 331

F.3d 972 (D.C. Cir. 2003), upon which petitioner relies,

ultimately affirmed the Court’s finding in Andantech L.L.C. v. - 21 -

Commissioner, T.C. Memo. 2002-97, a partnership-level proceeding,

that the partnership at issue should be disregarded for tax

purposes. See also ASA Investerings Pship. v. Commissioner, T.C.

Memo. 1998-305, affd. 201 F.3d 505 (D.C. Cir. 2000). Petitioner

argues that Andantech L.L.C. v. Commissioner, 331 F.3d 972 (D.C.

Cir. 2003), and ASA Investerings Pship. v. Commissioner, 201 F.3d

505 (D.C. Cir. 2000), do not help respondent’s position because

the courts in those cases did not explicitly address whether

“sham” or “lack of economic substance” are partnership items but

affirmed the Tax Court’s decisions after making a factual

finding. We find that these cases do support respondent’s

position and implicit in the analysis of the Court’s decisions by

the Courts of Appeal is an analysis of jurisdiction.

We also disagree that the determination whether a

partnership is a sham or lacks economic substance is more

appropriately determined at the partner level. The validity of

the partnership affects all partners; therefore, partner-level

determinations of validity would defy TEFRA’s purpose of

preventing inconsistent treatment between partners. See RJT Inv.

X v. Commissioner, supra at 737. Furthermore, “Congress vested

in the Secretary of the Treasury, not in the federal courts, the

authority to weigh and decide what items are most suitably

ascertained at the partnership level.” Id. at 738 n.8. As

discussed above, we hold that section 301.6231(a)(3)-1(b), - 22 -

Proced. and Admin. Regs., encompasses determinations whether a

partnership is a sham or lacks economic substance.

For the reasons discussed above, we hold that the

determination whether Petaluma is a sham, lacks economic

substance, or otherwise should be disregarded for tax purposes is

a partnership item over which we have jurisdiction. Accordingly,

we shall grant respondent’s motion and deny petitioner’s cross-

motion for summary judgment on this issue.

IV. Outside Basis

The FPAA adjusted Petaluma’s aggregate outside basis from

$24,943,505 to zero. In the explanation of items, respondent

also determined that neither Petaluma nor its partners had

established that the partners had outside bases greater than

zero. Petitioner argues the Court lacks jurisdiction under

section 6226(f) to redetermine the partners’ outside bases in

Petaluma because in petitioner’s view, outside basis is not a

partnership item within the definition of section 6231(a)(3).

Respondent acknowledges that as a general matter the Court

lacks jurisdiction in a partnership-level proceeding to calculate

outside basis. A number of our opinions indicate that, with

certain exceptions not present in this case, a partnership is not

required to determine its partners’ outside bases, nor do the

regulations expressly provide that outside basis is more

appropriately determined at the partnership level than the - 23 -

partner level. See Domulewicz v. Commissioner, 129 T.C. 11, 20

(2007); Ginsburg v. Commissioner, 127 T.C. at 82; Dial USA, Inc.

v. Commissioner, 95 T.C. at 4;6 Gustin v. Commissioner, T.C.

Memo. 2002-64.7 However, respondent argues that the Court has

jurisdiction to determine that outside basis is zero if a

partnership is disregarded for tax purposes because there can be

no outside basis in a disregarded partnership.

Petitioner argues that outside basis cannot be a partnership

item regardless of whether the Court disregards a partnership for

tax purposes because partnerships are not required to take

outside basis into account under subtitle A. In Dakotah Hills

Offices Ltd. Pship. v. Commissioner, T.C. Memo. 1996-35, and

6 The subch. S audit and litigation provisions were repealed by the Small Business Job Protection Act of 1996, Pub. L. 104- 188, sec. 1307(c)(1), 110 Stat. 1781, applicable to tax years beginning after Dec. 31, 1996, id. sec. 1317(a), 110 Stat. 1787. The definition of a subch. S item in former sec. 6245 was parallel to the definition of a partnership item in sec. 6231(a)(3). 7 The Court noted in dicta in Countryside Ltd. Pship. v. Commissioner, T.C. Memo. 2008-3 n.4, that under the circumstances of that case (where the jurisdictional issue was raised by the Commissioner, who had alleged in the FPAA gain to the partners in excess of their zero basis, and where basis was entirely determinable from partnership items), it had jurisdiction to determine the partners’ outside bases during a partnership-level proceeding.

Similarly, in Nussdorf v. Commissioner, 129 T.C. 30, 37, 44 (2007), the Court stated that determinations in notices of deficiency issued to the partners were partnership items, including a determination that one of the partners failed to establish that it had an outside basis greater than zero. However, this was consistent with the parties’ agreement. - 24 -

Olsen-Smith, Ltd. v. Commissioner, T.C. Memo. 2005-174, we held

that the critical factor is whether the item is required to be

taken into account by the partnership. See also Dial USA, Inc.

v. Commissioner, supra at 4.

Furthermore, regardless of whether Petaluma should be

disregarded for tax purposes, petitioner points out that the

regulations do not definitively provide that outside basis is an

item that is more appropriately determined at the partnership

level than the partner level. See sec. 301.6231(a)(3)-1, Proced.

& Admin. Regs. By contrast, section 301.6231(a)(5)-1T(b),

Temporary Proced. & Admin. Regs., supra, provides that “A

partner’s basis in his interest in the partnership is an affected

item to the extent it is not a partnership item.” This

definition indicates that outside basis can be a partnership item

in certain circumstances, such as where a partnership makes an

election under section 754 and must calculate a partner’s outside

basis to determine its own basis in its assets under section

734(b), see sec. 301.6231(a)(3)-1(a)(3), Proced. & Admin. Regs.,

or where one partnership owns an interest in a second partnership

and must determine its outside basis in the second partnership.

However, neither situation is present here.

This case presents a situation that is different from one

where the calculation of a partner’s outside basis requires

determinations to be made at the partner level. If there is no - 25 -

partnership, there will be no need to make further factual

determinations at the partner level. If a purported partner is

determined not to have had an interest in a partnership, no facts

available at the partner level will establish that the partner

had an outside basis in the partnership.

The regulations indicate that in a situation where no

partner-level determinations are necessary to determine outside

basis, this determination may be a partnership item. Section

301.6231(a)(3)-1(c)(2) and (3), Proced. & Admin. Regs., provides

that partnership items include determinations that relate to

contributions and distributions to the extent that those

determinations do not require information that is outside the

Court’s jurisdiction. Allen Family Foods, Inc. v. Commissioner,

T.C. Memo. 2000-327. Outside basis is related to a partner’s

contributions and share of distributions. Secs. 722, 733. If a

partnership is disregarded for tax purposes or a partner’s

participation in the partnership is disregarded, the Court may

determine that the partner’s outside basis is zero without

requiring a partner-level determination because there can be no

adjusted basis in a disregarded partnership. The Court will not

turn a blind eye to the fact that a partner has no outside basis

when this is a conclusion that stems directly from the Court’s

determination that a partnership or a partner’s participation in

the partnership should be disregarded. - 26 -

As discussed above, we have jurisdiction to determine

whether Petaluma should be disregarded for tax purposes. Because

petitioner will not contest this determination other than on

jurisdictional grounds, the effect of petitioner’s concession is

that Petaluma will be disregarded for tax purposes. There can be

no basis in a disregarded entity. If the partners have no

outside bases, we may treat their outside bases as zero. See

Rybak v. Commissioner, 91 T.C. 524, 566-567 (1988); Zfass v.

Commissioner, T.C. Memo. 1996-167, affd. 118 F.3d 184 (4th Cir.

1997). Accordingly, we shall grant respondent’s motion and deny

petitioner’s cross-motion for summary judgment on this issue.

V. Penalties

A. Jurisdiction

The ninth determination states that the adjustments of

Petaluma’s partnership items are attributable to a tax shelter

for which no substantial authority or reasonable basis has been

established. Furthermore, it determines that all of the

underpayments of tax resulting from those adjustments of

partnership items are attributable at a minimum to: (1) Gross or

substantial valuation misstatements penalized under section

6662(a), (b)(3), (e), and (h); (2) negligence or disregard of

rules or regulations penalized under section 6662(a), (b)(1), and

(c); or (3) substantial understatements of income tax penalized

under section 6662(a), (b)(2), and (d). - 27 -

A taxpayer is liable for an accuracy-related penalty of 20

percent of any part of an underpayment attributable to, in

pertinent part, a substantial valuation misstatement, negligence

or disregard of rules or regulations, or a substantial

understatement of income tax. Sec. 6662(a) and (b)(1), (2), and

(3).

As part of the Taxpayer Relief Act of 1997, Pub. L. 105-34,

sec. 1238(a), 111 Stat. 1026, Congress amended sections 6221 and

6226(f) to provide that the applicability of penalties that

relate to adjustments to partnership items is determined at the

partnership level. Before the amendment, the applicability of

all penalties was determined at the partner level because

penalties are affected items. See N.C.F. Energy Partners v.

Commissioner, 89 T.C. 741 (1987).

Section 6221 now provides: “the applicability of any

penalty, addition to tax, or additional amount which relates to

an adjustment to a partnership item * * * shall be determined at

the partnership level.”

Petitioner acknowledges that under section 6226(f) the Court

has jurisdiction to determine the “applicability of any penalty,

addition to tax, or additional amount which relates to an

adjustment to a partnership item.” (Emphasis added.) However,

petitioner argues that the penalties determined in the FPAA are

attributable to adjustments to affected items, not partnership - 28 -

items, and are accordingly outside the Court’s jurisdiction in

this partnership-level proceeding.

Respondent argues that even if the penalties are directly

attributable to adjustments to affected items, those items relate

to partnership items at least indirectly, and therefore they are

within the Court’s jurisdiction. For example, if Petaluma is

disregarded for tax purposes, RTV and RSV will be found to have

underpayments due to the sale of Scient stock that took basis by

reference to a partnership disregarded for tax purposes.

Petitioner counters that while the penalties may indirectly

relate to partnership items, the statute provides the Court with

jurisdiction only over penalties that directly relate to

partnership items.

Congress expanded the Court’s jurisdiction in partnership-

level proceedings when it amended sections 6221 and 6226(f), and

the legislative history accompanying those amendments suggests

that Congress intended the Court’s jurisdiction over penalties to

be interpreted broadly:

Reasons for Change

Many penalties are based upon the conduct of the taxpayer. With respect to partnerships, the relevant conduct often occurs at the partnership level. In addition, applying penalties at the partner level through the deficiency procedures following the conclusion of the unified proceeding at the partnership level increases the administrative burden on the IRS and can significantly increase the Tax Court's inventory. - 29 -

Explanation of Provision The bill provides that the partnership-level proceeding is to include a determination of the applicability of penalties at the partnership level. However, the provision allows partners to raise any partner-level defenses in a refund forum. [H. Rept. 105-148, at 594 (1997), 1997-4 C.B. (Vol. 1) 319, 916; emphasis added.]

The conference report suggests that the words “relates to” in

sections 6221 and 6226(f) should be read expansively.

We applied the amended versions of sections 6221 and 6226(f)

in Fears v. Commissioner, 129 T.C. 8, 10 (2007), Domulewicz v.

Commissioner, 129 T.C. at 23, and Bedrosian v. Commissioner, T.C.

Memo. 2007-376. These cases also indicate that the words

“relates to” should be read expansively. We hold that the FPAA

determined that the accuracy-related penalties apply as a result

of the determination that Petaluma should be disregarded for tax

purposes and this relation suffices to vest the Court with

jurisdiction over the penalties.8

B. The Valuation Misstatement Penalty

A “substantial valuation misstatement” occurs if the value

or the adjusted basis of any property claimed on any return of

tax is 200 percent or more of the correct amount. Sec.

8 In this case we do not make partner-level determinations for purposes of deciding the applicability of penalties at the partnership level. We do not address in this case whether we have jurisdiction in a partnership-level proceeding to determine affected items if the resolution of such items is required to finally determine the amount of a penalty. - 30 -

6662(e)(1)(A). The penalty is increased to 40 percent if the

underpayment of tax is the result of a gross valuation

misstatement, which is the valuation misstatement determined

under section 6662(e) after substituting “400 percent” for “200

percent”. Sec. 6662(h)(2)(A).

Respondent argues that while the amount of the penalty must

be determined at the partner level, the determination of whether

there is a substantial valuation misstatement should be

determined at the partnership level. Respondent argues that the

valuation misstatement penalty applies in this case because the

determinations made in the FPAA regarding Petaluma’s partnership

items cause the bases of its partners’ interests in the

partnership to be reduced to zero instead of $25 million

(collectively) as claimed. While the underpayments of tax the

partners were required to show on their returns were due to the

overstatement of each partner’s Scient stock, under section

732(b) the partners determined their adjusted bases in the Scient

stock by reference to their outside bases in Petaluma before its

liquidation.

As discussed above, if a partnership is disregarded for tax

purposes the Court has jurisdiction to treat the partners’

outside bases as zero. If a property has a basis of zero, any

basis claimed above that will be a valuation overstatement and

the penalty will apply. Rybak v. Commissioner, 91 T.C. at 566- - 31 -

567; Zfass v. Commissioner, T.C. Memo. 1996-167; Illes v.

Commissioner, T.C. Memo. 1991-449, affd. 982 F.2d 163 (6th Cir.

1992).

Petitioner argues that if the Court has jurisdiction over

the accuracy-related penalties under section 6662, respondent has

not met his burden of production under section 7491(c).

Petitioner stipulated that he is contesting only the valuation

misstatement penalty, and we treat this stipulation as binding on

petitioner. See Rule 91(e); Stamos v. Commissioner, 87 T.C. at

1454-1455. Therefore, we treat petitioner’s argument as only

relating to the valuation misstatement penalties and not

challenging the accuracy-related penalty on the bases of

negligence and substantial understatement of income tax.

Petitioner argues that respondent has not satisfied his burden of

production because he is asserting the penalties against the

individual partners, not the partnership.

Respondent argues that section 7491(c) does not apply

because that section applies only in proceedings “with respect to

the liability of any individual for any penalty”, and Petaluma is

not an individual. (Emphasis added.) See Santa Monica Pictures,

LLC v. Commissioner, T.C. Memo. 2005-104. Even if section

7491(c) does apply, we find that respondent has satisfied his

burden of production. As discussed above, petitioner does not

dispute, except on jurisdictional grounds, that Petaluma lacked - 32 -

economic substance and the partners’ outside bases are zero.

Therefore, we find that respondent has met the threshold

requirement to support his determination that the gross valuation

misstatement penalty applies.

Petitioner next argues that the valuation misstatement

penalties are inapplicable as a matter of law. According to

petitioner, the overstatement of the partners’ outside bases

resulted from respondent’s determinations that Petaluma and/or

the transactions it purportedly entered into should be

disregarded, not from an erroneous valuation. Petitioner argues

that this penalty was not aimed at, and should not be imposed on,

incorrect application or interpretation of the law. As support,

petitioner points to a statement in the report prepared by the

staff of the Joint Committee on Taxation, which accompanied the

enactment of section 6659, the predecessor to section 6662(b)(3):

“The Congress believed that a specific penalty was needed to deal

with various problems related to the valuation of property.”

Staff of Joint Comm. on Taxation, General Explanation of the

Economic Recovery Tax Act of 1981, at 332 (J. Comm. Print 1981).

Petitioner argues that we should follow the approach taken

by the Court of Appeals for the Fifth Circuit, that the valuation

overstatement penalty (the predecessor to the valuation

misstatement penalty) is not appropriate when the overstatement

of basis results from a transaction that has been disregarded in - 33 -

its entirety. See Heasley v. Commissioner, 902 F.2d 380, 383

(5th Cir. 1990), revg. T.C. Memo. 1988-408.

Respondent acknowledges that the Court of Appeals for the

Fifth Circuit has taken the position that valuation overstatement

penalties do not apply when the overstatement stems from

disregard of a transaction. However, respondent argues that we

should instead follow the approach we took in Zfass v.

Commissioner, supra, that “When a transaction lacks economic

substance, the correct basis is zero; any amount claimed is a

valuation overstatement” that may be subject to a penalty for a

valuation overstatement.

Under Golsen v. Commissioner, 54 T.C. 742, 757 (1970), affd.

445 F.2d 985 (10th Cir. 1971), the Court will follow the decision

of the Court of Appeals to which a case is appealable if the

Court of Appeals has already decided the issue. However, we will

give effect to our own views in cases appealable to courts that

have not yet decided the issue. Id. Because Petaluma had no

principal place of business at the time the petition was filed,

this case may be appealable to the Court of Appeals for the

District of Columbia Circuit. Sec. 7482(b)(1). The Court of

Appeals for the District of Columbia Circuit has not yet ruled on

the issue of whether the valuation misstatement penalty applies

to underpayments attributable to overstated bases in property - 34 -

involved in transactions that are shams and/or lack economic

substance.

The Courts of Appeals for the Second, Third, Fourth, Sixth,

and Eighth Circuits have affirmed this Court’s imposition of the

valuation overstatement or misstatement penalty where the

underpayment results from a sham transaction lacking economic

substance. Merino v. Commissioner, 196 F.3d 147, 158-159 (3d

Cir. 1999), affg. T.C. Memo. 1997-385; Zfass v. Commissioner, 118

F.3d at 191; Illes v. Commissioner, 982 F.2d at 167; Gilman v.

Commissioner, 933 F.2d 143, 151 (2d Cir. 1991), affg. T.C. Memo.

1989-684; Massengill v. Commissioner, 876 F.2d 616, 619-620 (8th

Cir. 1989), affg. T.C. Memo. 1988-427. Respondent argues that

this approach is consistent with section 1.6662-5(g), Income Tax

Regs., which provides:

(g) Property with a value or adjusted basis of zero.--The value or adjusted basis claimed on a return of any property with a correct value or adjusted basis of zero is considered to be 400 percent or more of the correct amount. There is a gross valuation misstatement with respect to such property, therefore, and the applicable penalty rate is 40 percent.

In keeping with the decisions of the majority of the Courts

of Appeals and our own prior decisions, we conclude that the

gross valuation penalty applies when the adjusted basis of

property is reduced to zero because a transaction was disregarded

as a sham or lacking economic substance and the taxpayer claims

an adjusted basis in the property of a greater amount. - 35 -

Petitioner next argues that the valuation penalty is not

appropriate when there is some other ground for disallowing the

entire portion of the disputed deduction and that this rule

applies here. See Gainer v. Commissioner, 893 F.2d 225 (9th Cir.

1990), affg. T.C. Memo. 1988-416. Petitioner argues that the

facts of this case are analogous to those in Weiner v. United

States, 389 F.3d 152 (5th Cir. 2004). In Weiner, the taxpayers

challenged the interest charged against them for “tax-motivated

transactions” pursuant to section 6621(c) (now repealed). Id. at

153. Section 6621(c) imposed an interest rate of 120 percent of

the statutory rate on “any substantial underpayment attributable

to tax motivated transactions”. Included in the definition of

“tax motivated transaction” in section 6621(c)(3)(A)(v) was any

“sham or fraudulent transaction”. In the FPAAs, the Internal

Revenue Service (IRS) asserted several bases for disallowing

certain deductions, one of which was “sham or fraudulent

transaction”. Id. at 159-160. However, because the taxpayers

settled with the IRS, there was never any need for a court to

examine the IRS’s alternative bases for disallowance or make

factual findings about their application. Id. at 160. The court

concluded that because the FPAA listed several independent

reasons for disallowing the taxpayers’ deductions, some of which

were not related to tax-motivated transactions, there was no way

to determine without additional superfluous litigation whether - 36 -

the taxpayers’ underpayments were attributable to a tax-motivated

transaction. Id. at 162.

The court in Weiner relied partially on Todd v.

Commissioner, 862 F.2d 540 (5th Cir. 1988), affg. 89 T.C. 912

(1987). In Todd v. Commissioner, supra at 541, the dispute was

over the application of the valuation overstatement penalty under

former section 6659(a). The court found that the taxpayers’

liability was attributable to the fact that because they did not

place their property in service before a certain date, the

valuation of the property had no impact on the tax actually owed.

Id. at 543.

Petitioner argues that if we find that all of the

determinations in the explanation of items are partnership items,

it will be impossible to determine which of the determinations

provide the grounds for imposing the valuation misstatement

penalty. While a determination that Petaluma was a sham and/or

lacked economic substance would cause the partners’ outside bases

in Petaluma to be reduced to zero, many of the other

determinations would have the same effect. According to

petitioner, because it is initially impossible to tell under

respondent’s theory why the partners’ outside bases are being

disallowed, under Weiner and Todd, the Court will not be able to

conclude that the penalty should be imposed because of a gross

valuation misstatement. - 37 -

Respondent acknowledges that the Court does not apply the

valuation misstatement penalty in cases where the deduction or

credit is disallowed for reasons other than the fact that the

value or basis of the property was inflated. Todd v.

Commissioner, 89 T.C. 912 (1987); Gainer v. Commissioner, T.C.

Memo. 1988-416. However, respondent argues that unlike the

situations in Todd and Gainer, in this case respondent’s

alternative arguments all affect the partners’ bases in the

partnership. Under any of respondent’s alternative arguments the

penalty is imposed on the same determination--the misstatement of

the partners’ outside bases. We agree with respondent that Todd

and Gainer are for that reason distinguishable from this case.

Petitioner finally argues that the valuation misstatement

penalty is improper because the factual record does not support

respondent’s arguments that Petaluma and the transactions in

which Petaluma and its partners engaged were shams and/or lacked

economic substance. To the contrary, petitioner argues that the

exhibits respondent submitted, particularly a memorandum

describing the offering of interests in Petaluma to potential

investors, prove that Petaluma was a valid partnership that

engaged in real transactions.

Petitioner argues that while he stipulated that he would

challenge jurisdiction only over the disputed items and the

propriety of imposing the valuation penalty, he has not conceded - 38 -

the valuation penalty just because the FPAA determines that

Petaluma was a sham and/or lacked economic substance. Petitioner

preserved the right to argue that sham and lack of economic

substance are not partnership items and argues that this right

necessarily includes the right to argue whatever is necessary to

mount that challenge. Petitioner argues that it is proper to

argue that the factual record supports a finding that Petaluma

engaged in real transactions with a real business purpose and,

therefore, respondent’s sham or lack of economic substance

argument is not supported by the record.

We agree that petitioner preserved the right to argue that

sham and lack of economic substance are not partnership items.

However, this is not the same as preserving the right to

challenge on factual grounds respondent’s position that Petaluma

was a sham and lacked economic substance. Petitioner stipulated:

2. If the Court determines that it has jurisdiction in this case, petitioner stipulates that he does not intend to call any witnesses or offer any evidence in this proceeding, or otherwise contest the determinations made in the FPAA other than the determination that the valuation misstatement penalty imposed by I.R.C. § 6662(a), (b)(3), (e), and (h) applies to any underpayment resulting from the adjustments to partnership items.

We construe this stipulation to mean that petitioner did not

intend to challenge on factual grounds the FPAA’s determination

that Petaluma was a sham or otherwise lacked economic substance.

The stipulation means that petitioner did intend to challenge the - 39 -

valuation misstatement penalty but only on the ground that it is

inapplicable to the adjustments to partnership items stated in

the FPAA, not on the ground that the adjustments to partnership

items were incorrect. It is incongruous that petitioner would

have stipulated that he would not call any witnesses or offer any

evidence if he intended to prove that Petaluma should be

respected for tax purposes in order to dispute the applicability

of the valuation misstatement penalties. This stipulation is

binding on the parties, and we do not find that justice requires

the Court to permit petitioner to qualify, change, or contradict

it. See Rule 91(e); Stamos v. Commissioner, 87 T.C. at 1454-

1455. Therefore, we hold that petitioner is precluded from

challenging this penalty on the merits during this proceeding.

However, if the partners have any personal defenses that they

wish to assert against the valuation misstatement penalty, they

may assert those defenses in a refund forum. Sec. 6230(c)(4).

On the basis of the foregoing, we shall grant respondent’s

motion for summary judgment and deny petitioner’s cross-motion

for summary judgment on this issue. Therefore, we need not

address whether the accuracy-related penalties for negligence or

understatement of income tax apply.

VI. The Remaining Determinations

As discussed above, petitioner argues that the Court lacks

jurisdiction over all of the determinations in the explanation of - 40 -

items. However, with the exception of the determinations already

discussed, petitioner makes no specific arguments regarding

whether the remaining determinations are partnership items.

Furthermore, given our holdings that Petaluma should be

disregarded for tax purposes and the partners have no outside

bases, the remaining issues are moot and unnecessary to decide to

support a holding for respondent. Accordingly, we shall not

address whether the remaining determinations in the explanation

of items are partnership items.

Based on the foregoing,

An appropriate order and

decision will be entered. - 41 -

APPENDIX

The explanation of items in Exhibit A to the FPAA issued to petitioner made the following additional determinations:

1. It is determined that neither Petaluma FX Partners, LLC nor its purported partners have established the existence of Petaluma FX Partners, LLC as a partnership as a matter of fact.

2. Even if Petaluma FX Partners, LLC existed as a partnership, the purported partnership was formed and availed of solely for purposes of tax avoidance by artificially overstating basis in the partnership interests of its purported partners.

The formation of Petaluma FX Partners, LLC, the acquisition of any interest in the purported partnership by the purported partner, the purchase of offsetting options, the transfer of offsetting options to a partnership in return for a partnership interest, the purchase of assets by the partnership, and the distribution of those assets to the purported partners in complete liquidation of the partnership interests, and the subsequent sale of those assets to generate a loss, had no business purpose other than tax avoidance, lacked economic substance, and, in fact and substance, constitutes an economic sham for federal income tax purposes. Accordingly, the partnership and the transactions described above shall be disregarded in full and any purported losses resulting from these transactions are not allowable as deductions for federal income tax purposes.

3. It is determined that Petaluma FX Partners, LLC was a sham, lacked economic substance and, under § 1.701-2 of the Income Tax Regulations, was formed and availed of in connection with a transaction or transactions in taxable year 2000 a principal purpose of which was to reduce substantially the present value of its partners’ aggregate federal tax liability in a manner that is inconsistent with the intent of Subchapter K of the Internal Revenue Code. It is consequently determined that:

a. the Petaluma FX Partners, LLC is disregarded and that all transactions engaged in by the purported partnership are treated as engaged in directly by its purported partners. This includes the determination that the assets purportedly acquired - 42 -

by Petaluma FX Partners, LLC, including but not limited to foreign currency options, were acquired directly by the purported partners.

b. the foreign currency option(s), purportedly contributed to or assumed by Petaluma FX Partners, LLC, are treated as never having been contributed to or assumed by said partnership and any gains or losses purportedly realized by Petaluma FX Partners, LLC on the option(s) are treated as having been realized by its partners.

c. the purported partners of Petaluma FX Partners, LLC should be treated as not being partners in Petaluma FX Partners, LLC.

d. contributions to Petaluma FX Partners, LLC will be adjusted to reflect clearly the partnership’s or purported partners’ income.

4. It is determined that the obligations under the short positions (written call options) transferred to Petaluma FX Partners, LLC constitute liabilities for purposes of Treasury Regulation §1.752-6T, the assumption of which by Petaluma FX Partners, LLC shall reduce the purported partners’ bases in Petaluma FX Partners, LLC in the amounts of $18,043,140 and $6,900,365 for Ronald Thomas Vanderbeek and Ronald Scott Vanderbeek, respectively, but not below the fair market value of the purported partnership interest.

5. It is determined that neither Petaluma FX Partners, LLC nor its purported partners entered into the option(s) positions or purchase [sic] the foreign currency or stock with a profit motive for purposes of § 165(c)(2).

6. It is determined that, even if the foreign currency option(s) are treated as having been contributed to Petaluma FX Partners, LLC, the amount treated as contributed by the partners under section 722 of the Internal Revenue Code is reduced by the amounts received by the contributing partners from the contemporaneous sales of the call option(s) to the same counter-party. Thus, the basis of the contributed option(s) is reduced, both in the hands of the contributing partners and Petaluma FX Partners, LLC. Consequently, any corresponding claimed increases in the outside basis in Petaluma FX Partners, LLC resulting from the contributions of the foreign currency option(s) are disallowed. - 43 -

7. It is determined that the adjusted bases of the long call positions (purchased call options), zero coupon notes, and other contributions purportedly contributed by the partners to Petaluma FX Partners, LLC has not been established under I.R.C. § 723. It is consequently determined that the partners of Petaluma FX Partners, LLC have not established adjusted bases in their respective partnership interests in an amount greater than zero (-0-).

8. It is further determined that, in the case of a sale, exchange, or liquidation of Petaluma FX Partners, LLC partners’ partnership interests, neither the purported partnership nor its purported partners have established that the bases of the partners’ partnership interests were greater than zero for purposes of determining gain or loss to such partners from the sale, exchange, or liquidation of such partnership interest.

9. Accuracy-Related Penalties

It is determined that the adjustments of partnership items of Petaluma FX Partners, LLC are attributable to a tax shelter for which no substantial authority has been established for the position taken, and for which there was no showing of reasonable belief by the partnership or its partners that the position taken was more likely than not the correct treatment of the tax shelter and related transactions. In addition, all of the underpayments of tax resulting from those adjustments of partnership items are attributable to, at a minimum, (1) substantial understatements of income tax, (2) gross valuation misstatement(s), or (3) negligence or disregarded [sic] rules or regulations. There has not been a showing by the partnership or any of its partners that there was reasonable cause for any of the resulting underpayments, that the partnership or any of its partners acted in good faith, or that any other exceptions to the penalty apply. It is therefore determined that, at a minimum, the accuracy- related penalty under Section 6662(a) of the Internal Revenue Code applies to all underpayments of tax attributable to adjustments of partnership items of Petaluma FX Partners, LLC. The penalty shall be imposed on the components of underpayment as follows:

A. a 40 percent penalty shall be imposed on the portion of any underpayment attributable to the gross valuation misstatement as provided by Sections 6662(a), - 44 -

6662(b)(3), 6662(e), and 6662(h) of the Internal Revenue Code.

B. a 20 percent penalty shall be imposed on the portion of the underpayment attributable to negligence or disregard of rules and regulations as provided by Sections 6662(a), 6662(b)(1), 6662(c) of the Internal Revenue Code.

C. a 20 percent penalty shall be imposed on the underpayment attributable to the substantial understatement of income tax as provided by sections 6662(a), 6662(b)(2), and 6662(d) of the Internal Revenue Code.

D. a 20 percent penalty shall be imposed on the underpayment attributable to the substantial valuation misstatement as provided by Sections 6662(a), 6662(b)(3), and 6662(e) of the Internal Revenue Code.

It should not be inferred by the determination of the Accuracy Related Penalty in this notice that fraud penalties will not be sought on any portion of an underpayment subsequently determined to be attributable to fraud or that prosecution for criminal offenses will not be sought under IRC § 7201, 7206 or other provisions of federal law if determined to be appropriate.