Free Response to Motion [Dispositive] - District Court of Federal Claims - federal

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS No. 05-1189 T (Judge Charles F. Lettow) ______________________ THOMAS H. McGANN and EVELYN G. McGANN

Plaintiffs, VS. UNITED STATES OF AMERICA, Defendant. ____________________ PLAINTIFFS' RESPONSE IN OPPOSITION TO DEFENDANT'S MOTION TO DISMISS PLAINTIFFS' COMPLAINT FOR LACK OF JURISDICTION AND BRIEF IN SUPPORT THEREOF ____________________

SALLIE W. GLADNEY TERESA J. WOMACK THOMAS E. REDDING REDDING & ASSOCIATES, P.C. 2914 W. T.C. Jester Houston, Texas 77018 Telephone: (713) 965-9244 Telecopier: (713) 621-5227 Attorneys for Plaintiffs Thomas H. McGann and Evelyn G. McGann

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TABLE OF CONTENTS TABLE OF CONTENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -iiTABLE OF AUTHORITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . -iii1. 2. 3. Response to the Government's Introduction and Question Presented . . . . . . . . . . . . . . . . . . 1 Response to the Government's Statement of the Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Response to the Government's Argument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 a. b. History of Section 6621(c) Penalty Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 TEFRA's Statutory Scheme . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 i. TEFRA's Partnership Item vs. Nonpartnership Item Structure . . . . . . . . . . . . . . . 10

ii. The Types of Nonpartnership Items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 iii. In the Context of TEFRA §6621(c) Penalty Interest is a Substantive Affected Item . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 iv. Section 6621(c) Penalty Interest is an Anomaly in the Tax Code . . . . . . . . . . . . . 15 v. c. d. Section 6230(c) Allows Only Six Months for a Partner to File Certain Refund Claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Imposing the §6621(c) Penalty Rate of Interest Was Improper as a Matter of Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 The McGanns' §6621(c) Claim Is Not Subject to The Six-Month Period for Filing a Refund Claim . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 i. Neither the Form 4549 Nor the NOA Sent to the McGanns Was Sufficient to Start the Limitations Period under §6230(c) . . . . . . . . . . . . . . . 20

ii. The McGanns' Claim is Not Based on the Erroneous Computation of a Computational Adjustment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 (1) The IRS's Decision to Impose the §6621(c) Penalty Rate of Interest is Not a Computational Adjustment . . . . . . . . . . . . . . . . . . . . . . . . 23 (a) The Government's Reliance on Olson is Misplaced . . . . . . . . . . . . . . . . 23 (b) The Government's Reliance on Treas. Reg. §301.6231(a)(6)-1T(b) Is Also Misplaced . . . . . . . . . . . . . . 25 (2) The McGanns' Claim Is Not Based on a Erroneous Computation . . . . . . . . . 29 e. The General §6511(a) Refund Claim Period Applies to Affected Items that Require Partner-Level Determinations . . . . . . . . . . . . . . . . . . . 31 i. The Government Relies on a Single, Minority Authority . . . . . . . . . . . . . . . . . . . 31

ii. The Majority Approach Proves Plaintiffs' Claims were Timely . . . . . . . . . . . . . . 31

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f.

The Field-Brookstone Approach Reconciles §6621(c) Within TEFRA's Statutory Scheme . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 i. The Field-Brookstone Approach Is Consistent With TEFRA's Legislative History . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

iii. Only the Field-Brookstone Approach Provides Adequate Opportunity to File a Refund Claim . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 iv. Only the Field-Brookstone Approach Provides Sufficient Time to Make Payment in Full . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35 v. 4. The IRS Has Recognized that the §6511(a) Period Applies to TEFRA Related §6621(c) Claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

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TABLE OF AUTHORITIES Cases Acierno v. C.I.R., T.C.Memo 1997-441, aff'd w/o publ. opinion, 185 F.3d 861 (Table) (3rd Cir. 1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4, 5 AK Steel Corp. v. U.S., 226 F.3d 1361 (Fed.Cir.2000). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 BedRoc Ltd., L.L.C. v. U.S., 541 U.S. 176, 124 S.Ct. 1587, 158 L.Ed.2d 338 (2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Bob Hamric Chevrolet, Inc. v. U.S., 849 F.Supp. 500 (W.D.Tex. 1994) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31, 32 Brookstone Corp. v. U.S., 1994 WL 621576 (S.D.Tex.) (unpublished), aff'd per curium, 58 F.3d 637 (5th Cir. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30-35 Callaway v. C.I.R., 231 F.3d 106 (2nd Cir. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11, 12 Carter v. U.S., 530 U.S. 255 120 S.Ct. 2159, 147 L.Ed.2d 203 (2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Chevron v. N.R.D.C., Inc., 467 U.S. 837, 104 S.Ct. 2668 (1984) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Colautti v. Franklin, 439 U.S. 379, 99 S.Ct. 675, 58 L.Ed.2d 596 (1979) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Comsat Corp. v. FCC, 250 F.3d 931 (5th Cir.2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Connecticut Nat. Bank v. Germain, 503 U.S. 249, 112 S.Ct. 1146, 117 L.Ed.2d 391 (1992) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Conway v. U.S., 50 Fed.Cl. 273 (2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Copeland v. C.I.R., 290 F.3d 326 (5th Cir. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 6-8, 15, 19, 20, 25 Copeland v. C.I.R., T.C.Memo 2000-181, aff'd in part, rev'd in part and remanded 290 F.3d 326 (5th Cir. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4, 5 Crooks v. Harrelson, 282 U.S. 55, 51 S.Ct. 49, 75 L.Ed. 156 (1930) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Dial U.S.A., Inc., v. C.I.R., 95 T.C. 1 (1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Duncan v. Walker, 533 U.S. 167, 121 S.Ct. 2120, 150 L.Ed.2d 251 (2001); . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 FCC v. RCA Comm., 346 U.S. 86 (1953) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Field v. U.S., 328 F.3d 58 (2nd Cir. 2003) ("Field I") . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15, 30, 33-35, 37 Field v. U.S., 381 F.3d 109 (2nd Cir. 2004) ("Field II") . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 -ivR:\DOCS\TAXCONT.T\TGW B9026.MC2.wpd

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Grapevine Imports, Ltd. v. U.S., 71 Fed.Cl. 324 (2006) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Griffin v. Oceanic Contractors, Inc., 458 U.S. 564, 102 S.Ct. 3245 (1982) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Hildebrand v. C.I.R. 28 F.3d 1024 (10th Cir.1994), cert. denied, 513 U.S. 1079, 115 S.Ct. 727, 130 L.Ed.2d 631 . . . . . . . . . . . . . . . . . . . . . . . . . . . 1, 5, 6, 18 Hill v. C.I.R., 204 F.3d 1214 (9th Cir. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 In re Lueders, 111 F.3d 1569, 42 USPQ2d 1481 (Fed.Cir.1997). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 In re Zurko, 142 F.3d 1447 (Fed.Cir. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Jama v. Immigration and Customs Enforcement, 543 U.S. 335 125 S.Ct. 694, 160 L.Ed.2d 708 (2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Korchak v. C.I.R., T.C. Memo 2005-244 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Krause v. C.I.R., 99 T.C. 132 (1992), aff'd sub nom. Hildebrand v. C.I.R. 28 F.3d 1024 (10th Cir.1994), cert. denied, 513 U.S. 1079, 115 S.Ct. 727, 130 L.Ed.2d 631. . . . . . . . . . . . . . . . . . . . 1-3, 5, 6, 14, 18, 19 Kuralt v. U.S., 866 F.Supp. 727 (S.D.N.Y., 1994) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18, 29 Ledford v. U.S., 297 F.3d 1378 (Fed.Cir. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Maxwell v. C.I.R., 87 T.C. 783 (1986) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10, 12 Meese v. Keene, 481 U.S. 465, 107 S.Ct. 1862, 95 L.Ed.2d 415 (1987) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Monahan v. C.I.R., 321 F.3d 1063 (11th Cir. 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 N.C.F. Energy v. C.I.R., 89 T.C. 741 (1987) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12-14, 32 Olson v. U.S., 172 F.3d 1311 (Fed. Cir. 1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12, 13, 23, 24 Olson v. U.S., 37 Fed. Cl. 727 (1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13, 24 Park `N Fly, Inc. v. Dollar Park & Fly, Inc., 469 U.S. 189, 105 S.Ct. 658, 83 L.Ed.2d 582 (1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Powell v. C.I.R., 96 T.C. 707 (1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Roberts v. C.I.R., 94 T.C. 853 (1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Roberts v. U.S., 242 F.3d 1065 (Fed. Cir. 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 -vR:\DOCS\TAXCONT.T\TGW B9026.MC2.wpd

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Santa Fe Snyder Corp. v. Norton, 385 F.3d 884 (5th Cir. 2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Statesman II Apartments, Inc. v. U.S., 66 Fed.Cl. 608 (2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Stenberg v. Carhart, 530 U.S. 914, 120 S.Ct. 2597, 147 L.Ed.2d 743 (2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Texaco Inc. v. Duhe 274 F.3d 911 (5th Cir. 2001) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Thompson v. U.S., 223 F.3d 1206 (10th Cir. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Thornsjo v. C.I.R., T.C. Memo 2001-129 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Todd v. C.I.R., 862 F.2d 540 (5th Cir.1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 U.S. v. Lanier, 520 U.S. 259, 117 S.Ct. 1219, 137 L.Ed.2d 432 (1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Univ. Heights at Hamilton Corp v. C.I.R., 97 T.C. 278 (1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Vulcan Oil Technology Partner, at al. v. C.I.R., Tax Court Docket No. 21530-87 . . . . . . . . . . . . . . . . . . . . . . . . . . 4-8, 11, 14, 18, 19, 29, 33 Weiner v. U.S., 389 F.3d 152 (5th Cir. 2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 8, 19, 20 White v. C.I.R., 95 T.C. 209, (1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Woody v. C.I.R., 95 T.C. 193 (1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12, 32 Yellow Transportation, Inc. v. Michigan, 537 U.S. 36 (2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Yocum v. U.S., 66 Fed.Cl. 579 (2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Statutes 26 U.S.C. §162 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 5, 7, 18-20 26 U.S.C. §174 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 5, 6, 18, 19 26 U.S.C. §183 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1, 2, 5, 6, 9, 14, 18-20 26 U.S.C. §213 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12, 13 26 U.S.C. §6031 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 26 U.S.C. §6211(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 26 U.S.C. §6212 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13, 15, 36 26 U.S.C. §6213 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15, 24 26 U.S.C. §6216(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 26 U.S.C. §6221 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 26 U.S.C. §6223 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 26 U.S.C. §6223(a)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 26 U.S.C. §6223(d)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 26 U.S.C. §6225(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 -viR:\DOCS\TAXCONT.T\TGW B9026.MC2.wpd

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26 U.S.C. §6226 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11, 17 26 U.S.C. §6226(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4, 11 26 U.S.C. §6230 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 26 U.S.C. §6230(a)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11, 32 26 U.S.C. §6230(a)(1)(A)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 26 U.S.C. §6230(a)(1)(A)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15, 32 26 U.S.C. §6230(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 3, 16-18, 20, 29, 30, 37 26 U.S.C. §6230(c)(1)(A)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20, 23, 28, 29 26 U.S.C. §6230(c)(2)(A)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20-23, 29, 31, 33-35, 38 26 U.S.C. §6230(d)(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31, 32, 38 26 U.S.C. §6231(a)(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11, 12, 30 26 U.S.C. §6231(a)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 26 U.S.C. §6231(a)(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 26 U.S.C. §6231(a)(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 3, 17, 20, 23, 25, 26, 28, 29 26 U.S.C. §6502(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 26 U.S.C. §6511 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 26 U.S.C. §6511(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8, 16, 30-34, 38 26 U.S.C. §6601 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3, 5, 22, 24, 25, 33, 34 26 U.S.C. §6621(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2-10, 13-25, 28-38 26 U.S.C. §6621(c)(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 26 U.S.C. §6621(c)(3)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 26 U.S.C. §6659 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14, 24 26 U.S.C. §6659(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 26 U.S.C. §6659(e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 26 U.S.C. §701 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 26 U.S.C. §702 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 26 U.S.C. §7422 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8, 30, 34 26 U.S.C. §§6221-6234, Tax Equity and Fiscal Responsibility Act of 1982, Pub.L. No. 97-248, 96 Stat. 324 ("TEFRA") . . . . 1, 3, 4, 10, 11, 13-16, 23, 30, 32-34, 36-38 28 U.S.C. §1346(a)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8, 30 28 U.S.C. §1491(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Regulations Temp. Treas. Reg. §301.6221-1T(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Treas. Reg. §1.183-2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5, 18 Treas. Reg. §1.6031-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Treas. Reg. §1.701-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Treas. Reg. §1.702-1(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Treas. Reg. §301.6231(a)(3)-1(a)(1)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Treas. Reg. §301.6231(a)(5)-1T(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Treas. Reg. §301.6231(a)(6)-1T(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25, 26, 33 Treas. Reg. §301.6621-2T . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5, 14, 18, 19 Miscellaneous 1989 IRS NSAR 9164, 1989 WL 1173044 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16, 38 -viiR:\DOCS\TAXCONT.T\TGW B9026.MC2.wpd

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1990 LGM TL-21, 1990 WL 1086208 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16, 34 1991 LGM TL-95, 1991 WL 1168400 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15, 16, 24 4 Arthur Willis et al., Partnership Taxation, §209.05 at 209-7, 209-12 (5th ed. 1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 H.R. Conf. Rep. 97-760, p.611, 97th Cong., 2nd Sess. 1982, P.L. 97-248, Tax Equity and Fiscal Responsibility Act of 1982 (Aug. 17, 1982), 1982 U.S.C.C.A.N. 1190, 1982 WL 25049 . . . . . . . . . . . . . . . . . . . . 11, 34 H.R.Rep. No. 101-247, at 1388, 1394 (1989), reprinted in 1989 U.S.C.C.A.N.1906, 2858-59, 2864 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 H.Rep. No. 101-247, 1388, 1393, 1394 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Statement by Senator Pryor introducing S.1784 at 135 Cong. Rec. S13893-7 (0ctober 24, 1989), 1989 WL 186980 (Cong.Rec.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Tax Reform Act of 1984, §144(c) Pub.L. No. 98-369, Div. A, July 18, 1984, 98 Stat. 494. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Tax Reform Act of 1986, Pub.L. No. 99-514, 100 Stat. 2744, §1511(c)(1)(A)-(C) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

-viii-

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS No. 05-1189 T (Judge Charles F. Lettow) ______________________ THOMAS H. McGANN and EVELYN G. McGANN Plaintiffs, VS. UNITED STATES OF AMERICA, Defendant. ____________________ PLAINTIFFS' RESPONSE IN OPPOSITION TO DEFENDANT'S MOTION TO DISMISS PLAINTIFFS' COMPLAINT FOR LACK OF JURISDICTION AND BRIEF IN SUPPORT THEREOF ____________________ 1. Response to the Government's Introduction and Question Presented Plaintiffs Thomas H. McGann and Evelyn G. McGann ("the McGanns") were subject to an IRSdrafted default decision in a TEFRA1 partnership-level case in the Tax Court that did not address the merits of the partnership items and simply granted the IRS's motion to dismiss which stated that the partnership item adjustments were "computed based on §183 in accordance with the [Tax Court] opinion in Krause."2 [Doc12:65¶34; 68]3 Based on that decision alone the IRS automatically

1

TEFRA consists of the partnership procedures codified at 26 U.S.C. §§6221-6234, as enacted by the Tax Equity and Fiscal Responsibility Act of 1982, Pub.L. No. 97-248, 96 Stat. 324 and as thereafter amended. TEFRA is also known as subchapter C of the I.R.C.
2

Krause v. C.I.R., 99 T.C. 132 (1992), aff'd sub nom. Hildebrand v. C.I.R. 28 F.3d 1024 (10th Cir.1994), cert. denied, 513 U.S. 1079, 115 S.Ct. 727, 130 L.Ed.2d 631.
3

References to [Doc12:"x"¶"y"] are to Bates stamped page no. "x" at paragraph no. "y" of the Exhibits to the Supplement to Plaintiffs' Original Complaint at Document #12 in this case. 1
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assessed interest at the penalty rate under §6621(c)4 on the resulting tax liability. One month prior to entry of that decision, the Fifth Circuit held: (i) §183 could not be a basis to impose the §6621(c) penalty rate of interest on a tax liability arising from a partnership-level adjustment, and (ii) the actual basis for disallowance in Krause (profit motive under §162 and §174) could not, as a matter of law, be used to impose the §6621(c) penalty rate of interest on any tax liability, partnership related or otherwise.5 Shortly thereafter, the Fifth Circuit held that in circumstances similar to those here, as a matter of law, the §6621(c) penalty rate of interest cannot be imposed via any of the other bases that might have been addressed by the Tax Court.6 After Copeland and Weiner were issued, the McGanns filed a claim for refund of the amount of interest they paid as a result of the IRS's improper imposition of the §6621(c) penalty rate of interest. The government now tries a Hail Mary pass to deny this Court the opportunity to reach the merits by asking it to hold for the first time in any court that the IRS's substantive decision to impose the §6621(c) penalty rate of interest is merely an "erroneous computation" of a "computational adjustment," i.e. a math mistake, and, therefore, subject to the six-month limitations period to file a claim for refund under §§6230(c) and 6231(a)(6). The issue raised by the government's motion is not as simplistic as "[w]hether plaintiffs filed their administrative refund claim for tax motivated interest outside the time period Congress prescribed in §6230(c)." [GB:2]7 The issue of first impression raised by the government's motion is:
4

Unless otherwise indicated all references to section, §, and the Code are to the Internal Revenue Code at 26 U.S.C. Copeland v. C.I.R., 290 F.3d 326 (5th Cir. 2002). Weiner v. U.S., 389 F.3d 152 (5th Cir. 2004).

5

6

7

References to [GB:"x"] are to page "x" of the Defendant's Motion to Dismiss Plaintiffs' Complaint for Lack of Jurisdiction and Brief in Support Thereof ("the government's motion to dismiss") at Document #13 in this case. 2
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Whether the IRS's substantive decision to impose the §6621(c) penalty rate of interest is a "computational adjustment" as defined by §6231(a)(6) such that any claim for refund must be filed within the six month period under §6230(c), or whether the interest paid due to §6621(c)'s increased penalty rate is subject to the same limitations period as other claims for refund not based on a mere computational error or not otherwise "attributable to" a partnership item, i.e. the normal two/three year limitations period under §6511? 2. Response to the Government's Statement of the Case From roughly 1978 to 1986 a group of limited partnerships known as the Elektra partnerships were formed with the "general objective of, among other things, investing in enhanced oil recovery (EOR) technology for the recovery of oil and natural gas."8 In 1983 Thomas H. McGann ("McGann") was a limited partner in Drake Oil Technology Partners (EIN:84-0856853) ("Drake Oil"), an Elektra partnership. [GB:B-1]9 On his 1983 federal tax return, McGann recognized his share of gains and losses from his investment in Drake Oil. [GB:B-1; B-6] In 1984, Congress amended §6621(c) allowing the IRS to impose interest at 120% of the normal §6601 rate on any 'substantial' underpayment that is "attributable to" one of five expressly defined tax motivated transactions ("TMTs").10 The IRS disallowed Elektra partnership deductions and imposed the §6621(c) penalty rate of interest on numerous Elektra partners for pre-TEFRA tax years 1978-1982. In 1986, three preTEFRA Elektra partners, Krause, Hildebrand, and Acierno, filed separate suits in the United States
8

Krause at 133-34. References to [GB:B-"x"] are to page "x" of Appendix B to the government's motion to dismiss.

9

10

Originally codified as §6621(d), it was amended and redesignated as §6621(c) by the Tax Reform Act of 1986, Pub.L. No. 99-514, 100 Stat. 2744, § 1511(c)(1)(A)-(C). Section 6621(c) applies to interest accruing after December 31, 1984. Tax Reform Act of 1984, §144(c), Pub.L. No. 98-369, Div. A, July 18, 1984, 98 Stat. 494. Section 6621(c) was repealed in 1989 with several other penalty provisions and replaced with a single "accuracy-related" penalty by the 1989 Act. See H.R.Rep. No. 101-247, at 1388, 1394 (1989), reprinted in 1989 U.S.C.C.A.N.1906, 2858-59, 2864. Despite its repeal, §6621(c) still applies to tax years prior to 1990. A copy of §6621(c) for 1983, the tax year in issue here, is attached at [A-1] References to [A-"x"] are to page no. "x" of Plaintiffs' Appendix A attached to this response. 3
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Tax Court challenging the IRS's proposed disallowances. Hildebrand was consolidated into Krause which became the test case challenging the IRS's Elektra related disallowances.11 Acierno was a preTEFRA partner in Drake Oil.12 On April 6, 1987, the IRS issued a TEFRA Notice of Final Partnership Administrative Adjustment ("FPAA") for Drake Oil's 1983 tax year. [GB:B-21 to B-31] The FPAA totally disallowed Drake Oil's partnership deductions on 23 independent, alternative grounds ­ 2 TMTs and 21 non-TMTs ­ without assigning discrete dollar adjustments.13 [GB:B-27 to B-30] In response, Louis Coppage, the tax matters partner ("TMP") for seven Elektra partnerships including Drake Oil, challenged their 1983 FPAAs by filing a single §6226(a) TEFRA partnership-level case in the Tax Court at Vulcan Oil Technology Partner, at al. v. C.I.R..14 [GB:B-12 to B-20] In 1989, Congress repealed §6621(c) and other penalties finding that the IRS abused them by imposing them in situations not intended by Congress. See the discussion below at pp. 9 - 10. In 1990, Alvin C. Copeland, a partner in three pre-TEFRA Elektra partnerships, filed an individual case in the Tax Court contesting, among other things, the IRS decision to impose the §6621(c) penalty rate of interest on his 1979, 1981 and 1982 partnership related liabilities.15

11

Krause, at 133.
rd

12

Acierno v. C.I.R., T.C.Memo 1997-441, aff'd without published opinion, 185 F.3d 861 (Table) (3 Cir. 1999).
13

The alternative TMT grounds for disallowance were that the claimed deductions materially distort income (1.(c)); and the partners were not at risk within the meaning of § 465 for any amounts in excess of those actually paid. The other 21 undifferentiated, alternative grounds to completely disallow the partnership deductions were not TMTs. [GB:B-27, B-28] Many other TEFRA partnership level Tax Court cases were filed for other Elektra partnerships, including three at White Rim v. C.I.R., docket nos. 5931-89, 932-91 and 15556-91.
15

14

Copeland v. Commisioner, T.C.Memo 2000-181, aff'd in part, rev'd in part and remanded 290 F.3d 326 (5th Cir. 2002). 4
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In 1992, the Tax Court issued its opinion in Krause disallowing Elektra related partnership losses because the partnerships lacked the profit motive required under §§162 and 174. Because neither of these sections provides a method or criteria for determining profit motive, the Tax Court used the criteria under §183 and Treas. Reg. §1.183-2 to determine profit motive for purposes of disallowing the losses under §§162 and 174.16 TMTs include "[a]ny deduction disallowed for any period under §183, related to an activity engaged in by an individual or an S corporation that is not engaged in for profit."17 But §183, by its unambiguous terms, cannot apply to activities engaged in by partnerships. Deductions disallowed under §§162 and 174 are not TMTs. In 1994, the Tenth Circuit Court of Appeals issued Hildebrand18 ­ the appeal of the Tax Court's decision in Krause ­ holding that: The Tax Court [in Krause] disallowed under 26 U.S.C. §183 the taxpayers' deductions for losses resulting from investments in the limited partnerships because the partnerships did not have the requisite profit motive and imposed an increased interest rate on tax-motivated transactions under 26 U.S.C. §§6601 and 6621(c). Other Elektra partners, including Copeland and Acierno, continued to fight the imposition of the §6621(c) penalty rate of interest. In 1997, the Tax Court issued its opinion in Aceirno19 holding that the 1981 Drake Oil deductions were substantively similar to the partnership deductions in Krause. Acierno appealed and, in 1999, the Third Circuit upheld the Tax Court, without a written opinion. In 2000, the Tax Court similarly ruled against Copeland who appealed to the Fifth Circuit.20 On December 20, 2001, the IRS filed in the Vulcan Oil Tax Court case a Motion to Dismiss for

16

Krause at 168. Treas. Reg. §301.6621-2T, A4. [A-3] Hildebrand at 1026. Acierno, supra. Copeland, T.C.Memo 2000-181, supra. 5
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17

18

19

20

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Lack of Prosecution requesting that partnership items be adjusted which were "computed based on §183 in accordance with the opinion in Krause." [Doc12:65¶34] As one of the grounds for its motion the IRS stated that Louis Coppage had defaulted his duties as TMP and there was no functioning TMP for the Elektra partnerships then before the court in Vulcan Oil. [Doc12:56¶8 to 62¶28] On May 13, 2002, the Fifth Circuit reversed the Tax Court's §6621(c)decision in Copeland. That Court recognized that in Krause the Elektra partnership deductions were disallowed under §§162 and 174, not under §183. As the Fifth Circuit stated: It bears emphasizing, however, that the factors from I.R.C. §183 are only tools for determining the requisite profit objective under I.R.C. §§162 and 174; deductions for partnership expenses are not allowed or disallowed directly under I.R.C. §183 itself.21 The Fifth Circuit further held that even if Krause had disallowed the partnership deductions under §183, §183 does not apply to partnerships and is not a TMT for purposes of imposing §6621(c) penalty interest on partners for partnership related losses. In Copeland the Fifth Circuit held that the §183 analysis in Krause and Hildebrand was "flatly incorrect" as a matter of law, that no portion of the underlying tax liability was attributable to any defined TMT, and, therefore, Copeland, an Elektra partner, was not subject to the §6621(c) penalty rate of interest. On June 13, 2002, exactly one month after Copeland was issued, the Tax Court entered an Order and Order of Dismissal and Decision in Vulcan Oil stating: "ORDERED that respondent's Motion to Dismiss for Lack of Prosecution filed December 20, 2001, is granted." [Doc12:68] Therefore, the default decision was restricted to partnership level adjustments "based on §183 in accordance with the opinion in Krause." The Tax Court never examined the merits of the case and made no determinations as to any specific basis for disallowing the partnership-item deductions. Between May 13, 2002 (the day the Fifth Circuit entered Copeland) and June 13, 2002 (the day

21

Copeland, at 335. Emphasis added. 6
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the Tax Court granted the IRS's motion to dismiss in Vulcan Oil), the IRS made no attempt to amend its motion to dismiss in Vulcan Oil to address the Copeland decision, not even with regard to those Elektra partners in the Fifth Circuit, nor did it attempt to revise the decision before it became final. On February 28, 2003, the IRS issued a Form 4549 to the McGanns that states "all or part of the underpayment of tax ... is a substantial understatement attributable to [TMTs], as defined by §6621(c)(3) ...." [GB:B-6] Emphasis added. The Form 4549 plainly states that the amount of "TMT Interest - computed 03/22/2003 on TMT underpayment" is "0.00." [GB:B-5] Emphasis added. The Form 4549 gives no basis for the TMT allegation except that "[t]his report is prepared based on a Tax Court decision, docket #21530-87, from the partnership, George C. Walueff, EIN #51-0121089. ... If you have any questions, contact your [TMP]." [GB:B-5] When the IRS sent the McGanns the Form 4549 it was well aware that there was no Drake Oil TMP for them to contact. The IRS made no determinations and conducted no partner-level examination of the McGanns before making a naked decision to impose the §6621(c) penalty rate of interest. On March 24, 2003 the IRS assessed tax ($8,620.00) and total interest ($57,475.04) against the McGanns. [GB:B-8] The IRS mailed a notice of that assessment (an "NOA") to the McGanns. [B-1 to B-3]22 The NOA does not disclose that the IRS imposed the §6621(c) penalty rate of interest, much less what portion of the tax underpayment was "attributable to" a TMT, what TMT it was supposedly "attributable to," or the amount of interest actually assessed at the §6621(c) punitive rate. [B-1 to B-3] The McGanns paid the liabilities in full by application of a prior remittance of $8,620.00 on March 11, 2003, and payments of $17,312.79 and $40,162.25 on April 14, 2003 and April 21, 2003, respectively. [GB:B-9] On October 25, 2004, the Fifth Circuit issued its opinion in Weiner relying in part on the IRS's

22

References to [B-"x"] are to page "x" of the attached Plaintiffs' Appendix B. 7
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formula at §301.6621(c)-2T, A-5 to hold that where the IRS does not designate a specific TMT as the sole basis for disallowing a discrete, designated dollar amount of the proposed adjustment, §6621(c) cannot be imposed unless every basis for disallowance asserted in the FPAA was examined to determine exactly what portion of the adjustments were specifically "attributable to" a TMT. Under Weiner, if an FPAA proposes an undifferentiated, blanket disallowance on numerous alternative grounds, then if even one basis for disallowance proposed in the FPAA is a non-TMT the §6621(c) penalty rate of interest cannot be imposed unless every ground for disallowance asserted in an FPAA is examined and a discreet dollar value of disallowance assigned to each basis. Vulcan Oil was a default decision, the Tax Court never examined, and made no determinations as to, any of the 2 TMT or 21 non-TMT bases in the FPAA for disallowing Drake Oil's 1983 deductions. On April 15, 2005, the McGanns filed a claim for refund of $18,309.66, the portion interest assessed at the §6621(c) penalty rate based upon Copeland and Weiner. [Doc12:11 to 97] The McGanns' claim states that it "is timely ... filed within two years from the date of payment," a reference to the §6511(a) normal limitations period of two years from payment [Doc12:8] The government never acted on the McGanns' refund claim. On November 10, 2005 the McGanns timely filed this suit and plainly stated that it was filed under 26 U.S.C. §7422 and 28 U.S.C. §§1346(a)(1) and 1491(a), which have long been recognized as waiving sovereign immunity and establishing this Court's jurisdiction.23 See p.1 ¶3 and ¶4 of Plaintiffs' Original Complaint at Document no. 1 in this case.

23

Ledford v. U.S., 297 F.3d 1378, 1382 (Fed.Cir. 2002); Roberts v. U.S., 242 F.3d 1065, 1067 (Fed. Cir. 2001). 8
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3. a.

Response to the Government's Argument History of Section 6621(c) Penalty Interest In 1984, after McGann made his investment and took his deductions, Congress enacted §6621(c)

but strictly limited its application to a substantial underpayment (over $1,000) of tax that is "attributable to" one of the TMTs expressly defined by statute and in the regulations. [A-1] Congress intended §6621(c) to be used as a tool to manage the Tax Court's backlogged docket by encouraging settlement of proposed deficiencies.24 As modified in 1986 and applicable here, §6621(c)(3)(A) and §301.6621(c)-2T identify only a handful of transactions as TMTs. [A-1 to A-4] Of the 23 grounds for disallowing the Drake Oil partnership items, only two are TMTs: any loss disallowed by reason of section 465(a) and any credit disallowed under section 46(c)(8), and any deduction disallowed for any period under section 183, relating to an activity engaged in by an individual or an S corporation that is not engaged in for profit. It quickly became clear that the IRS was abusively imposing the §6621(c) penalty rate of interest in a manner never intended by Congress. In 1989, after two years of study, hearings, and debate, Congress repealed §6621(c) and other penalties because they were "determined too routinely and automatically by the IRS,"25 and they were a "morass of inconsistency and irrationality" that discouraged rather than encouraged compliance and under which a "hapless taxpayer [could] find himself, or herself, confronting the [I.R.C.] over a tax deficiency, where the penalties and interest

Todd v. C.I.R., 862 F.2d 540, n.14 (5th Cir.1988), citing H.Conf.Rep. No.98-861 (June 23, 1984) [A-5 to A-9]; Weiner v. U.S., 255 F.Supp.2d 624, n.47 (S.D.Tex., 2002).
25

24

H.Rep. No. 101-247, 1388, 1393, 1394. [A-14 to A-20] But, because Congress failed to repeal §6621(c) retroactively, the IRS may still impose it for tax years 1989 and prior. 9
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have been piled on to the extent that they are twice the amount of tax in dispute."26 Congress repealed §6621(c) but not retroactively. The IRS can still impose the §6621(c) penalty rate on any tax liability for pre-1990 tax years that is "attributable to" a TMT. At this late date it is rare to find a normal pre-1990 tax liability where the limitations period for assessment is still open. But TEFRA partnership level cases offer a devil's playground for the IRS to again abuse its ability to impose the §6621(c) penalty rate of interest because it is not uncommon for TEFRA partnership level cases to linger in the Tax Court for 10-15 years before the limitations period to assess begins to run against the IRS. Here the amount of interest assessed against the McGanns was over 6.66 times the amount of tax in dispute ($57,475/$8,620). [GB:B-8] Because the partnership related liabilities here arise from 1983, it is necessary to understand not just §6621(c) but also how §6621(c) and the regulations interact with the TEFRA provisions. b. TEFRA's Statutory Scheme Partnerships generally do not pay income tax; they file information returns.27 Each partner individually reports and recognizes his share of partnership income, gains, losses, deductions, etc.28 Before 1982, to adjust an item on a partnership return the IRS had to separately examine each partner's return and could not ensure consistent adjustments among partners. In response Congress enacted TEFRA to consolidate some of the partnership audit and adjustment procedures.29 i. TEFRA's Partnership Item vs. Nonpartnership Item Structure TEFRA mandates that "the tax treatment of any partnership item shall be determined at the

26

Statement by Senator Pryor introducing S.1784 at 135 Cong. Rec. S13893-7 (0ctober 24, 1989), 1989 WL 186980 (Cong.Rec.). [A-27] S.1784 was ultimately enacted as a part of P.L. 101-239.
27

§§701, 6031; Treas. Reg. §§1.701-1, 1.6031-1; Conway v. U.S., 50 Fed.Cl. 273, 276 (2001). §§701, 702; Treas. Reg. §1.702-1(a). Effective for tax years after 9-3-82; see generally Maxwell v. C.I.R., 87 T.C. 783, 787 (1986). 10
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28

29

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partnership level" and establishes mutually exclusive procedures to (i) adjust the statutorily defined "partnership items" in a centralized, partnership-level proceeding under subchapter C, and then (ii) make any nonpartnership item determinations at the partner level under the normal deficiency procedures of subchapter B.30 "Partnership item" is a term of art defined "as any item required to be taken into account for the partnership's taxable year under any provision of subtitle A...." §6231(a)(3). Subtitle A addresses the financial information reported on a tax return. A "nonpartnership item" is any "item which is (or is treated as) not a partnership item." §6231(a)(4). Under TEFRA, for the IRS to adjust any partnership item it must first issue an FPAA for that partnership tax year. §§6223(a)(2) and (d)(2). Judicial review of the of the partnership item adjustments proposed in the FPAA can only be had at the partnership level and, for 1983, the jurisdiction of the reviewing court is expressly restricted to "partnership items." §§6226(a), (b), (f). A partner is a party to, may participate in, and is bound by, the partnership-level case only as long as he has an ongoing interest in the outcome. §§6226(c), (d). Consequently, McGann was subject to the Vulcan Oil decision. Once the partnership-level case is concluded, the IRS may automatically assess any purely §6221; Temp. Treas. Reg. §301.6221-1T(a); Callaway v. C.I.R., 231 F.3d 106, 108, 110 (2nd Cir. 2000); See also §6230 (subchapter B non-TEFRA procedures apply to nonpartnership/affected item adjustments that are not merely computational changes). This mandatory bifurcation is reiterated in §§6211(c), 6216(4), 6221, 6223, 6225(a), 6230(a)(1), and 6226 and confirmed by the legislative history: Neither the Secretary nor the taxpayer will be permitted to raise nonpartnership items in the course of a partnership proceeding nor may partnership items, except to the extent they become nonpartnership items under the rules, be raised in proceedings relating to nonpartnership items of a partner. H.R. Conf. Rep. 97-760, p.611, 97th Cong., 2nd Sess. 1982, P.L. 97-248, Tax Equity and Fiscal Responsibility Act of 1982 (Aug. 17, 1982), 1982 U.S.C.C.A.N. 1190, 1982 WL 25049. [A-30] See also 4 Arthur Willis et al., Partnership Taxation, §209.05 at 209-7, 209-12 (5th ed. 1996). 11
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"computational adjustments" against each respective partner without further notice. But for the IRS to assess tax related to nonpartnership items that are not purely computational adjustments it must follow the separate partner-level procedures under subchapter B.31 ii. The Types of Nonpartnership Items In general, there are two types of nonpartnership items: pure nonpartnership items and "affected items." Pure nonpartnership items are items such as a partner's rental income from property unrelated to the partnership. Adjustments to partnership items do not alter pure nonpartnership items and they are not relevant to this particular case. But "affected items" are. "Affected items" are defined as "any item to the extent such item is affected by a partnership item." §6231(a)(5). The statute makes it clear and it is well settled that some affected items have a partnership item component,32 such as the deductions reported by partnerships, as well as, the legal and factual determinations that underlie the determination of the timing, amount, and characterization of the partnership's deductions.33 There are two types of affected items.34 The first are "computational affected items" that require only a mathematical computation to record the change in a partner's tax liability resulting from the proper treatment of partnership items once the partnership proceeding is complete.35 Examples include carryovers,36 the threshold for deduction of medical expenses under §213, and alternative

31

Maxwell at 788; Callaway at 108. See N.C.F. Energy v. C.I.R., 89 T.C. 741, 743-4 (1987). §6231(a)(3); Treas. Reg. §301.6231(a)(3)-1(a)(1)(i).

32

33

See Olson v. U.S., 172 F.3d 1311, 1317 (Fed. Cir. 1999) citing Woody v. C.I.R., 95 T.C. 193, 202 (1990).
35

34

See Olson, 172 F.3d at 1317. See Olson, 172 F.3d at 1318. 12
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minimum tax ("AMT").37 A change to a partner's adjusted gross income due to partnership item adjustments causes a mechanical change in the §213 threshold and/or AMT that can be computed mathematically without further determinations at the partner level. As the name implies, computational affected items are both computational adjustments and affected items. The second type of affected items are referred to as "substantive affected items."38 Liabilities arising from substantive affected items cannot be assessed automatically because they require additional fact determinations that can only be made at the partner level once the partnership-level proceeding is concluded.39 Examples include "at risk," basis, interest, and penalties.40 Purely computational adjustments can be assessed without further notice at the conclusion of the partnership level proceedings. But the IRS must follow the subchapter B deficiency procedures and issue a statutory notice of deficiency ("stat notice") before making substantive affected item assessments. §6230(a)(1)(A)(1) and §6212. iii. In the Context of TEFRA §6621(c) Penalty Interest is a Substantive Affected Item It is well-settled that §6621(c) penalty interest is a substantive affected item because it requires

37

See Treas. Reg. §301.6231(a)(5)-1T(a). Olson v. U.S., 37 Fed. Cl. 727, 732 (1997). See Olson, 172 F.3d at 1317-8, citing N.C.F. Energy at 744.

38

39

40

Roberts v. C.I.R., 94 T.C. 853, 861 (1990) ("At risk" was a substantive affected item because the amount at risk depended on the operation of third party side agreements more appropriately determined at the partner level.); Dial U.S.A., Inc., v. C.I.R., 95 T.C. 1, 5-6 (1990) (Basis is not a partnership item because it is not required to be taken into account for the taxable year under subtitle A); Univ. Heights at Hamilton Corp v. C.I.R., 97 T.C. 278, 281-282 (1991) (Basis is a substantive affected item because a partner's basis is partially comprised of partnership items, such as debt.); N.C.F. Energy at 745-746 (Interest and penalties are "affected items" that relate to partnership items but must be determined at the individual level.); Monahan v. C.I.R., 321 F.3d 1063, 1066 11th Cir. 2003) (§6651(a)(1) late filing penalty and §6653(a)(1) and (2) negligence penalties are affected items requiring an "affected item notice of deficiency."). 13
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findings of fact peculiar to each partner.41 The most common finding of fact cited by the unanimous authorities, and one at issue in this case, is the determination of the amount of a partner's underpayment that is attributable to a TMT.42 That amount is determined by applying the IRS's formula at §301.6621(c)-2T, A-5, which can only be done at the individual partner level. Also, some TMTs are themselves affected items because they have both partnership item and nonpartnership item components. E.g., the §6659(c) valuation overstatement penalty is a TMT and a substantive affected item when imposed in a partnership context.43 Imposing §6659 depends on (i) the proper value of partnership property, a partnership item established at the partnership-level, and (ii) a separate partner-level determination of (a) what portion of the underpayment is "attributable to" the valuation understatement, and (b) whether the partner had a personal defense.44 The IRS often imposes the §6621(c) penalty rate because it asserts the tax underpayment was attributable to sham transactions, a TMT.45 But sham has a two prong test, lack of economic substance and lack of profit motive. All of the authorities to reach the issue of sham in the context of TEFRA partnership related §6621(c) claims have unanimously agreed that the profit motive at issue is the partner's individual profit motive, a fact issue which can only be determined at the

41

See N.C.F. Energy at 744. See N.C.F. Energy at 746. Powell v. C.I.R., 96 T.C. 707 (1991), citing N.C.F. Energy.

42

43

§6659(e); Thornsjo v. C.I.R., T.C. Memo 2001-129; Korchak v. C.I.R., .T.C. Memo 2005-244; Thompson v. U.S., 223 F.3d 1206, 1211 (10th Cir. 2000).
45

44

The Vulcan Oil Tax Court decision referenced the IRS's motion to dismiss which invoked "§183 in accordance with the opinion in Krause." In its motion to dismiss the McGanss' complaint, the government misrepresents the holding in Krause as stating that "[i]n Krause, the Tax Court disallowed partnership deductions under §183." [GB: 3] However, also in its motion the government appears to assert, albeit unclearly, that the Drake Oil partnership deductions were invalid because they were based on sham transactions. [GB:3] Therefore, the McGanns also address the specifics of the sham transaction analysis in this response. 14
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individual partner level after the partnership level proceeding is complete.46 iv. Section 6621(c) Penalty Interest is an Anomaly in the Tax Code In non-TEFRA cases, the provisions at subchapter B require the IRS to issue a stat notice before it can assess additional tax. §6212. A stat notice gives taxpayers a pre-payment right to challenge proposed adjustments in the Tax Court. §6213. But §6621(c) is assessed as interest, not tax and, therefore, the subchapter B stat notice procedures and prepayment rights do not apply. In TEFRA partnership cases, the IRS cannot assert the §6621(c) penalty rate of interest in an FPAA (the partnership-level equivalent of a stat notice). An FPAA is limited restricted to proposed adjustments to partnership items; §6621(c) is an affected item not a partnership item.47 The underlying partnership item determinations necessary to impose the §6621(c) penalty rate must be proposed in the FPAA, but application of the §6621(c) rate is not and should not be included in the FPAA.48 Therefore, for 1983, §6621(c) could not be addressed in the partnership-level proceeding. Once the partnership-level proceeding is complete, the IRS must follow the subchapter B procedures and send each partner a stat notice for any assessments of tax or penalties related to substantive affected items. §6230(a)(1)(A)(i). But the subchapter B procedures and rights do not apply to §6621(c), even though it is a substantive affected item. Moreover, for tax year 1983, it is generally accepted that because interest is not a tax deficiency, the Tax Court lacks prepayment jurisdiction over §6621(c).49 Consequently,

See discussion in Copeland at 337-8; Weiner v. U.S., 255 F. Supp.2d 673, 678-88 (S.D.TX. 2002).
47

46

Field v. U.S., 328 F.3d 58 (2nd Cir. 2003) ("Field I").

48

1991 LGM TL-95, 1991 WL 1168400. The McGanns do not cite this LGM as precedential authority but as persuasive indicia that the IRS recognizes and follows the McGanns' approach. See Barlow v. C.I.R., 301 F.3d 714, 720-22 (6th Cir. 2003) (discussing rationale behind the Tax Court's lack of pre-payment jurisdiction over §6621(c) penalty interest and limits on overpayment 15
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49

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for 1983, partners have no pre-payment forum to contest the imposition of the §6621(c) penalty rate.50 A partner's only recourse to a TEFRA related §6621(c) assessment is to pay it and challenge the improper assessment in a partner-level refund action such as the McGanns' case here.51 If the IRS issues a stat notice for any other substantive affected item it may, but is not required to, included any §6621(c) assessment. It is the IRS's longstanding procedure not to include §6621(c) determinations in such stat notices, if any, and to automatically assess penalty interest with the tax ­ even though additional partner level fact determinations are required before §6621(c) can be imposed.52 v. Section 6230(c) Allows Only Six Months for a Partner to File Certain Refund Claims Because taxpayers have only a post-payment right to judicial review, the procedures associated with the assessment of §6621(c) penalty interest and the procedures associated with perfecting a post-payment claim are of particular concern and illustrate why the standard §6511(a) period should apply to §6621(c) refund claims. Generally, under §6511(a) a taxpayer may file a claim for refund of any overpayment within two years after it is paid. But in a TEFRA context, §6230(c) imposes an abbreviated six month period

jurisdiction), citing White v. C.I.R., 95 T.C. 209, (1990). It is also generally agreed that the Tax Court has overpayment jurisdiction over §6621(c) as long as the claim is brought in conjunction with a petition for a redetermination for the same year. §6621(c)(4); Barlow at 720-2.
50

The Sixth Circuit has held that the lack of a pre-payment forum to challenge §6621(c) penalty interest does not violate taxpayer Fifth Amendment due process rights because "...the law is well settled that the availability to a taxpayer of a post-payment judicial forum in which to obtain a determination of his tax obligations is sufficient to satisfy due process requirements." Barlow at 722. Barlow at 720.

51

52

1991 LGM TL-95, 1991 WL 1168400; 1990 LGM TL-21, 1990 WL 1086208; 1989 IRS NSAR 9164, 1989 WL 1173044. These sources are not cited for precedent but as persuasive evidence of IRS procedures concerning the imposition of §6621(c) penalty interest. 16
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to file certain refund claims. For tax year 1983, §6230(c) states that for (c) Claims Arising Out of Erroneous Computations, etc.-- (1) IN GENERAL.-- A partner may file a claim for refund on the grounds that-- (A) the Secretary erroneously computed any computational adjustment necessary-- (i) to make the partnership items on the partner's return consistent with the treatment of the partnership items on the partnership return, or (ii) to apply to the partner a settlement, a final partnership administrative adjustment, or the decision of a court in an action brought under §6226 or §6228(a), ... . (2) TIME FOR FILING CLAIM .-- (A) UNDER PARAGRAPH (1)(A ).--Any claim under paragraph (A)(1) shall be filed within 6 months after the day on which the Secretary mails the notice of computational adjustment to the partner. [Emphasis added.] A "computational adjustment" is defined as the "change in the tax liability of a partner which properly reflects the treatment under [subchapter C] of a partnership item." §6231(a)(6) [Emphasis added]. Computational adjustments are the simple mathematical, mechanical calculations of a partner's tax liability that result from calculating the partner's share of partnership item adjustments and calculating the resulting changes to his personal tax liability. While computational adjustments are restricted by statute to changes in a partner's tax liability, they are not restricted per se to partnership items only. As discussed above, some nonpartnership item adjustments may also be pure "computational adjustments," But the IRS's substantive decision to impose the §6621(c) penalty rate of interest is not because it does not cause any change in "tax liability." Even if the IRS's decision to impose §6621(c) was a pure computational adjustment, a partner's claim for refund of that interest based on a substantive legal challenge would still not be subject to the §6230(c) six month limitations period. This is because §6230(c) does not apply to all refunds arising from computational adjustments. The plain language of §6230(c) is unambiguous. Section 17 ...

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6230(c) applies only to claims for refund on the grounds that the IRS "erroneously computed any computational adjustment." The abbreviated six-month limitations deadline applies only where the IRS makes a math mistake in calculating a "computational adjustment."53 The IRS cannot impose §6621(c) without first making substantive determinations at the partner level. A substantive decision by the IRS to bypass these requirements is not a math mistake. Therefore, by its own clear terms, §6230(c) cannot apply to a claim for refund based on the IRS's substantive decision to impose the §6621(c) penalty rate of interest even if that decision were deemed to meet the statutory requirements of a "computational adjustment." c. Imposing the §6621(c) Penalty Rate of Interest Was Improper as a Matter of Law The default decision entered in the Vulcan Oil partnership-level Tax Court case granted the IRS's motion to dismiss, which proposed to disallow the Drake Oil partnership items at issue here "based on §183 in accordance with the [Tax Court's] opinion in Krause." [Doc12:65¶34] In Krause, an Elektra partnership test case, the Tax Court used the criteria under §183 and Treas. Reg. §1.183-2 to determine profit motive for purposes of disallowing the partnership losses under §§162 and 174.54 The partnership losses were disallowed under §§162 and 174, not §183. Deductions disallowed under §§162 and 174 are not TMTs.55 Later courts mistakenly confused the issues and held that §6621(c) was appropriate because Krause had disallowed the Elektra partnership deductions under §183, which can be a TMT56

53

Kuralt v. U.S., 866 F.Supp. 727, 728 (S.D.N.Y., 1994) (describing §6230(c)(1)(A) claims for "mathematical error").
54

Krause at 168. §6621(c)(3)(A) and 26 C.F.R. §301.6621(c)-2T.

55

56

Hildebrand at 1026; Hill v. C.I.R., 204 F.3d 1214, 1220 (9th Cir. 2000); see also Treas. Reg. §301.6621-2T, A4. 18
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One month before the Vulcan Oil decision was entered, the Fifth Circuit in Copeland held that those later courts were "both imprecise and flatly incorrect" because Krause actually held that the partnership losses were disallowed under §§162 and 174, not §183, and, therefore, as a matter of law the IRS could not impose the §6621(c) penalty rate of interest on an Elektra partner because neither §§162 or 174 is a TMT.57 The Fifth Circuit further held that even if the Krause court had disallowed the partnership deductions under §183 that disallowance would be invalid for purposes of §6621(c) because, as to §6621(c), §183 applies only to "activity engaged in by an individual or an S corporation," therefore it cannot apply to activity engaged in by partnerships.58 On October 25, 2004, the Fifth Circuit issued its opinion in Weiner,59 relying in part on the IRS's formula at §301.6621(c)-2T, A-5 to hold that where the IRS does not designate a specific TMT as the sole basis for disallowing a discrete dollar amount of the proposed adjustment, the §6621(c) penalty rate of interest cannot be imposed unless every proposed basis for disallowance asserted in an FPAA was examined to determine exactly what portion of the adjustments were specifically "attributable to" which TMT. Under Weiner, if an FPAA (like the 1983 Drake Oil FPAA here) proposes an undifferentiated, blanket disallowance on multiple, alternative grounds, then if even one basis for disallowance proposed in that FPAA is a non-TMT, the §6621(c) penalty rate of interest cannot be imposed unless every ground for disallowance asserted in the FPAA was examined and a discreet dollar value assigned to each basis, even if it was -0-. Twenty-one of the 23 grounds asserted in the 1983 Drake Oil FPAA were non-TMTs. [GB:B-27 to B-30] Vulcan Oil was a default decision, the Tax Court never examined or made any determinations as to even one of the 23 bases

57

Copeland at 336, 338. Copeland at 334. Weiner, supra. 19
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58

59

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proposed in the FPAA for completely disallowing the Drake Oil partnership deductions. The government's motion to dismiss the McGanns' complaint conspicuously neglects to address the Fifth Circuit's analyses in Copeland and Weiner and how they impact the issues before this Court. The McGanns' counsel have litigated §6621(c) partnership related refund actions against the government since before 1997. They represented Dr. Weiner at trial and before the Fifth Circuit and argued the winning §§162/183 analysis in an amicus brief in Copeland. The government's argument here ­ that the IRS's legal decision to impose the §6621(c) penalty rate of interest without making any substantive partner-level determinations is merely a math error such that it qualifies as an "erroneous computation" of a "computational adjustment" under §6231(a)(6) ­ was never asserted in those prior cases and appears to be a Hail Mary effort in this litigatio