Free Reply to Response to Motion - District Court of Federal Claims - federal

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS

GRAPEVINE IMPORTS, LTD., and T-TECH, INC., as Tax Matters Partner Plaintiffs, v. UNITED STATES OF AMERICA, Defendant.

§ § § § § § § § § §

NO. 05-296T (Judge Allegra)

UNITED STATES' REPLY TO PLAINTIFFS' RESPONSE TO UNITED STATES' CROSS MOTION FOR PARTIAL SUMMARY JUDGMENT

Respectfully submitted, GROVER HARTT, III Attorney of Record Tax Division U.S. Department of Justice 717 N. Harwood, Suite 400 Dallas, Texas 75201 (214) 880-9721 (Main) (214) 880-9741 (Fax) EILEEN J. O'CONNOR Assistant Attorney General MILDRED L. SEIDMAN Chief, Court of Fed. Claims Section CHRISTOPHER R. EGAN DAVID R. HOUSE Of Counsel December 29, 2005

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TABLE OF CONTENTS

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

A.

To the Extent Statutes of Limitations on the Assessment and Collection are Found to be Ambiguous, They Must be Construed in Favor of the Government. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 The Plain Language of Section 6229(a) Establishes a Minimum Period of Three Years Within Which a Tax Attributable to a Partnership Item Shall Not Expire; It Does Not Impose Any Outer Boundary When Limitations Will Expire. . . . . . 6 Section 6229(a) Does Not Impose a Separate and Independent Period of Limitations on the Examination of Partnership Returns. . . . . . . . . . . . . . . . . . . . 7 Legislative History Supports the Conclusion that Section 6229(a) Does Not Establish a Separate and Independent Statute of Limitations for Examining Partnership Returns. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Section 6229 Does Not Limit The Issuance of FPAAs or the Adjustment of Partnership Items . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Section 6501(e)'s Six-Year Assessment Period for Substantial Omissions of Income Applies to the Tigues 1999 Tax Year . . . . . . . . . . . . . . . . 12 1. 2. The Tigues Omitted Gain From the Sale of Their Partnership Interests . 12 The "Clues" to be Gleaned From the Tigues' Returns Were Incomplete and Misleading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

B.

C.

D.

E.

F.

CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

TABLE OF AUTHORITIES Cases: AD Global Fund, LLC v. United States, 67 Fed. Cl. 657 (2005) . . . . . . . . . . . . . . . . . . 3,5 Andantech, L.L.C. v. Commissioner, 331 F.3d 972 (D.C. Cir. 2003) . . . . . . . . . . . . . . . . 3 i

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Badaracco v. Commissioner, 464 U.S. 386 (1984) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,4 Bowers v. New York & Albany Lighterage Co., 273 U.S. 346, 350 (1927) . . . . . . . . . . . . 3 Bufferd v. Commissioner, 506 U.S. 523, 527 n. 6 (1993) . . . . . . . . . . . . . . . . . . . . . . . 4, 8 Colony, Inc. v. Commissioner, 357 U.S. 28 (1958) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Colony, Inc. v. Commissioner, 26 T.C. 30 (1965) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Green v. Commissioner, 963 F.2d 783, 789 (5th Cir. 1992) . . . . . . . . . . . . . . . . . . . . . 11 O'Gilvie v. United States, 519 U.S. 79, 91-92 (1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Phinney v. Chambers, 392 F.2d 680 (5th Cir. 1968) . . . . . . . . . . . . . . . . . . . . . . . 13,14,17 Rhone-Poulenc Surfactants & Specialties, L.P. v. Commissioner, 114 T.C. 533 (2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Roberts v. Commissioner, 94 T.C. 853 (1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,11 Seatrain Shipbuilding Corp. v. Shell Oil Co., 444 U.S. 572, 596 (1980) . . . . . . . . . . . . 10 Siben v. Commissioner, 930 F.2d 1034, 1037 (2nd Cir. 1991) . . . . . . . . . . . . . . . . . . 8,11 United States v. Updike, 281 U.S. 489 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 United States v. St. Paul, Minn. & Manitoba Ry, 247 U.S. 310, 314 (1918) . . . . . . . . . . 3

Statutes: 26 U.S.C.: § 6229 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,3,5,6,7,8,9,10,18 § 6501 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,5,6,8,9,10,12,12,13,14 26 U.S.C. (1939 Code): § 275 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Miscellaneous: IRS Chief Counsel Notice 2003-020, IRS CCN CC-2003-020, available at 2003 WL 24016805 (June 25, 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,16 IRS Notice 2000-44, 2000-36 I.R.B. 255, 2000 WL 1138430 . . . . . . . . . . . . . . . . . . . . 16 Michael I. Saltzman, IRS Practice and Procedure, ¶ 5.01, p. 5-3, Rev'd Second Ed. 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 1992 Ways and Means Committee Report on Proposal to Suspend Partner Statute of Limitations During Bankruptcy. H.R. Rep. 102-63, Title IV, Subtitle C, Part II(3b), reprinted in 1992 WL 206185, at *142 (June 30, 1992) . . . . . . . . . . . . . . 9

ii

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS GRAPEVINE IMPORTS, LTD., and T-TECH, INC., as Tax Matters Partner Plaintiffs, v. UNITED STATES OF AMERICA, Defendant. § § § § § § § § § §

NO. 05-296T (Judge Allegra)

UNITED STATES' REPLY TO PLAINTIFFS' RESPONSE TO UNITED STATES' CROSS MOTION FOR PARTIAL SUMMARY JUDGMENT During December of 1999, Joseph and Virginia Tigue participated in a Son of BOSS tax shelter intended to inflate the basis in their partnership, Grapevine Imports, Ltd., so that they could sell their 99 percent interest in it and eliminate the tax bill that would otherwise be due on the substantial gain from its sale. They contend that by virtue of this tax shelter, instead of a taxable gain of $9,954,926 from their sale of Grapevine, they realized a loss of $45,077. Because of their tax shelter loss in 1999, the Tigues had no need for a net operating loss ("NOL") carryover from 1998 and simply carried it forward for use in their 2000 year. The Internal Revenue Service challenges the validity of the Tigues' Son of BOSS transaction and asserts that they owe taxes for both 1999 and for 2000 since the NOL should have been absorbed in 1999. To make that challenge, it is undisputed that the Service must first make an adjustment to the Grapevine partnership's tax return for 1999, the year of the Son of Boss transaction. Grapevine's Form 1065 return was filed on April 19, 2000; the Service's Final Partnership Administrative Adjustment ("FPAA") was mailed to Grapevine on December 17, 2004. The issue for this Court to decide is whether the FPAA was barred by limitations.

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The FPAA was timely for the Tigues' 2000 tax year under 26 U.S.C. § 6501(a), and it was timely for their 1999 tax under 26 U.S.C. § 6501(e). Our brief in support of our motion for partial summary judgment explains the methodology for calculating the time periods applicable to both of these years. As we explained there, and reiterate below, the decisive issue for resolving the dispute for both years is whether the applicable statute of limitations is the one provided for the only taxpayers involved in this case, Joseph and Virginia Tigue, or a supposed statute of limitations for their pass-through entity, the Grapevine partnership. The undisputed facts establish that the 2000 year was timely under the three-year statute. We believe they do the same for the 1999 year under the six-year statute, although we acknowledge that Tigues' disclosure defense for that year could raise a factual question that would have to be resolved at trial. At this point, we shall summarize our position on the issues now before the Court.

A.

To the Extent Statutes of Limitations on the Assessment and Collection are Found to be Ambiguous, They Must be Construed in Favor of the Government. The linchpin of Grapevine's motion for summary judgment is "that the statute of

limitations specifically prescribed for partnership level items in Section 6629(a) has expired."1 The wheel comes off its axle, however, because every court that has considered Grapevine's contention has rejected it. First the Tax Court (in a reviewed opinion),2 then the District of

Plaintiffs' Response to United States' Cross Motion for Partial Summary Judgment and Reply to the Government's Opposition to Plaintiffs' Motion for Summary Judgment ("Grapevine's Response & Reply"), p. 1. Rhone-Poulenc Surfactants & Specialties L.P. v. Commissioner, 114 T.C. 533 (2000), appeal dism'd & rem'd, 249 F.3d 174 (3d Cir. 2001).
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2

1

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Columbia Circuit,3 and now another judge of this Court4 have all held that section 6229(a) does not impose a separate and independent statute of limitations on the time available to the Service to propose adjustments to partnership items reported on a partnership's return. Confronted with this unanimously adverse body of law, Grapevine has been compelled to piece together a theory in support of its continued advocacy of this proposition. Grapevine's point of beginning is its pronouncement that tax statutes, "including provisions of limitations embodied in them, are to be construed liberally in favor of the taxpayer." Not only is the pronouncement wrong as a matter of law, but it is also predicated upon an invalid assumption. Grapevine attempts to escape the Supreme Court's holding that statutes imposing limitations upon the assessment or collection of taxes are to be strictly construed in favor of the Government5 by arguing that the dispute in this case is only about the extent of the limitation imposed by section 6229(a) and that "there is no dispute that Congress intended Section 6229 as a bar."6 Quite to the contrary, we do dispute that section 6229 is a "bar." Our position was and is that section 6229(a) provides a minimum period during which the limitation imposed by section 6501 "shall not expire."7 Nothing in the plain language of section 6229(a) imposes a time at which limitations shall expire. Accordingly, Grapevine's attempt to create some kind of corollary to Badaracco in which the general rule of construing

3 4 5 6 7

Andantech, L.L.C. v. Commissioner, 331 F.3d 972 (D.C. Cir. 2003). AD Global Fund, LLC v. United States, 67 Fed. Cl. 657 (2005). Badaracco v. Commissioner, 464 U.S. 386 (1984). Grapevine's Response & Reply, p. 6.

Brief Supporting United States' Cross Motion for Partial Summary Judgment (US MSJ Br."), pp. 17-23.
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limitations statutes in favor of the Government can be turned on its head is flawed from the beginning. We do not accept the premise of Grapevine's argument. The theory is also legally unsound in any case. We explained that the rules for construing tax statutes for or against the taxpayer or the Government vary depending upon the type of statute being construed.8 Grapevine has not responded to this important distinction. Instead, it has merely cited more cases and quoted its own earlier brief interpreting Bowers v. New York & Albany Lighterage Co. in an attempt to buttress its theory.9 interprets the very same case quite differently. But as a matter of statutory construction, when vague or ambiguous, statutes of limitations on assessment and collection are construed strictly in favor of the government, because as the Supreme Court has said, "the public interest should not be prejudiced by the default or negligence of public officers. (Citing Bowers v. New York & Albany Lighterage Co., 273 U.S. 346, 350 (1927) discussing United States v. St. Paul, Minn. & Manitoba Ry., 247 U.S. 310, 314 (1918).) Michael I. Saltzman, IRS Practice and Procedure, ¶ 5.01, p. 5-3, Rev'd Second Ed. 2004. Among the additional cases cited by Grapevine is United States v. Updike.10 The language in this opinion about limitations in tax statutes being construed in favor of taxpayers may very well be characterized as dicta and as an aberration in any event. If the language really means what Grapevine says, then it cannot be squared with what the Supreme Court itself said more than half a century later in Badaracco and several subsequent cases.11 Either the Updike language is dicta or it has been overruled sub silentio.
8 9

A noted commentator

US MSJ Br., p. 13, including footnote 47. Grapevine's Response & Reply, p. 5. 281 U.S. 489 (1930).

10 11

Bufferd v. Commissioner, 506 U.S. 523, 527 n. 6 (1993); O'Gilvie v. United States, 519 U.S. 79, 91-92 (1996).
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All of Grapevine's contrived theorizing cannot overcome the vast body of case law holding that statutes of limitations imposed upon the Government's ability to assess and collect taxes are to be construed in the Government's favor. Grapevine's attempt to dismiss the conclusions of numerous courts of appeals we cited as "reflexive" or improper12 is simply unavailing. Both the courts and the commentators recognize this rule, and "only Plaintiffs' interpretation"13 is to the contrary. The court in AD Global gave thorough consideration to a contention remarkably similar to the one now advanced by Grapevine. Noting the line of Supreme Court cases calling for tax statutes to be construed in favor of taxpayers relied upon by Grapevine, the court concluded that because a statute of limitations was at issue, the Badaracco rule should govern. As the court explained If Gould were to trump Badaracco, every attempt by the Government to make use of the Badaracco standard would be met and defeated by Gould. Such a rule would swallow the Badaracco presumption entirely, in which case the Supreme Court should never even have bothered to utter it. This cannot possibly be the law. Perhaps the sheer obviousness of this point is why the Supreme Court failed to mention it explicitly in its Badaracco opinion.14 The language of section 6229(a) is plain in establishing a minimum period during which the general period of limitations provided by section 6501 shall not expire and does not impose an outer boundary when limitations will expire. Rules of construction are unnecessary. To the extent that this Court should be concerned that the statute is ambiguous, then the ambiguity should be construed in favor of the Government.

12 13 14

Grapevine's Response & Reply, p. 8. Id., pp. 2-3. 67 Fed. Cl. at 694, n. 45.
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B.

The Plain Language of Section 6229(a) Establishes a Minimum Period of Three Years Within Which a Tax Attributable to a Partnership Item Shall Not Expire; It Does Not Impose Any Outer Boundary When Limitations Will Expire. The language of section 6229(a) could not be plainer: It states that limitations "shall not

expire before" three years from the date of the filing of the partnership return or the last day for the filing of the return without regard to extensions. Grapevine would have this Court rewrite the statute to say limitations "shall expire" three years from the date, etc. In support of this inescapable request for judicial legislation, Grapevine responds to our reliance on the plain language of the statute by saying that even a "causal reading" of that statute leads to "too many discrepancies, inconsistencies and complexities."15 Then to support this attack, Grapevine leaves the language of section 6229(a), plain or otherwise, and confines itself to analysis of other parts of the statute in attempt to create its "discrepancies, inconsistencies and complexities." This approach has nothing to do with the plain language of section 6229(a); it is an effort to create confusion by looking to other provisions of the law. Apart from referring the Court to the analysis in its opening brief, Grapevine really limits itself to a restatement of those points. Accordingly, there is little left for us to do other than refer the Court to our earlier response to those same points. The Tax Court in Rhone-Poulenc and Judge Miller in AD Global thoroughly considered how section 6229(a) operates in the context of TEFRA and the general limitations statute, section 6501. It is true that Congress could have written the statute differently. It could even have written it the way Grapevine would like. It did not. Since it did not, the statute should be applied as it was written.

15

Grapevine Response & Reply, p. 9.
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C.

Section 6229(a) Does Not Impose a Separate and Independent Period of Limitations on the Examination of Partnership Returns. In our opening brief, we noted the distinction between the aggregate and entity theories

of partnership taxation. Grapevine insists that TEFRA embraces the entity theory under all circumstances in order to erect its strawman argument that TEFRA requires all partners to be treated identically in all circumstances; and, therefore ­ according to Grapevine ­ section 6229(a) must be given a procrustean application cutting off any adjustment of a partnership item as it may apply to any partner three years after the filing of the partnership return. TEFRA itself refutes Grapevine's contention. We listed five different places in section 6229 itself where the aggregate theory, not the entity theory, was codified: 1. § 6229(b)(1) ­ individual partners may extend the period referred to in § 6229(a) by agreement with the Commissioner; 2. § 6229(c)(1) ­ different limitations periods may apply to different partners when a fraudulent partnership return is filed; 3. 4. § 6229(e) ­ different limitations period for unidentified partners; § 6229(f) ­ different limitations period when partnership items are converted to non-partnership items; and 5. § 6229(h) ­ bankruptcy proceeding may suspend the period in § 6229(a) for individual partner. See U.S. MSJ Br., pp. 24-25. In support of its statement that these "exceptions do not swallow

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the rule," Grapevine says that these provisions apply in "fairly unusual circumstances."16 Even if this characterization were to accepted as correct for purposes of argument, it still establishes the point that the entity theory is not uniformly and exclusively applied in TEFRA. Grapevine then concludes this point by saying "More importantly, all of these exceptions are contained in Section 6229 itself and make no mention of Section 6501." The significance of this last statement is not clear. What is clear is that partnerships are not taxpaying entities. In a pre-TEFRA case, the Second Circuit explained that a partnership return does not report any tax imposed by this title and does not furnish the information necessary to calculate an individual partner's income tax.17 That court held that for purposes of statutes of limitations, it is the return filed by the individual taxpaying partner, not the partnership return upon which the partner's liability is predicated, that triggers the running of the period. A short time later, the same court reached the same conclusion with respect to an individual share-holder in an S corporation based in part upon its decision in Siben and was affirmed by the Supreme Court.18 Grapevine asks this Court to hold that the treatment of TEFRA partnerships for purposes of limitations is at odds with the treatment of other pass-through entities. Its insistence on an entirely entity-theory application of TEFRA provides part of the underpinning for that request. This insistence ignores TEFRA's discriminating application of both the entity and the aggregate theories. The only sensible result is the one reached by the three other courts that have

16 17

Id., p. 11. Siben v. Commissioner, 930 F.2d 1034, 1036 (2d Cir. 1991), cert. denied, 502 U.S. 963 Bufferd v. Commissioner, 952 F.2d 675 (2d Cir. 1992), aff'd, 506 U.S. 523 (1993).
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(1991).
18

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considered this issue: Limitations are determined by when taxpayers (partners) file their returns, not their partnerships.

D.

Legislative History Supports the Conclusion that Section 6229(a) Does Not Establish a Separate and Independent Statute of Limitations for Examining Partnership Returns. Grapevine's brief rejoinder on legislative history does not really provide any new

analysis.19 The extensive analysis of legislative materials in AD Global thoroughly refutes Grapevine's expansive statement that "All contemporaneous legislative and interpretative materials support" its conclusion that section 6229(a) is an exclusive period of limitations for partnership items. Grapevine's legislative and interpretative materials are much more inconclusive that it would like to believe. In 1992, Congress did offer several definitive statements that "The period for assessing tax with respect to partnership items generally is the longer of the periods provided by section 6229 or section 6501."20 Confronted with the unequivocal statement, Grapevine responds that subsequent legislative history is a hazardous basis for inferring prior Congressional intent. In some situations, that admonition may have merit. Of course, in this case, Grapevine cannot offer any earlier statement so directly on point that is to the contrary. Moreover, the Supreme Court itself has also relied upon subsequent legislative history, as we pointed out in our opening brief.21

Grapevine Response & Reply, p. 11, part D. 20 1992 Ways and Means Committee Report on Proposal to Suspend Partner Statute of Limitations During Bankruptcy. H.R. Rep. 102-63, Title IV, Subtitle C, Part II(3b), reprinted in 1992 WL 206185, at *142 (June 30, 1992). These materials were cited at page 25 of our opening brief.
21

19

US MSJ Br., p. 26. Seatrain Shipbuilding Corp. v. Shell Oil Co., 444 U.S. 572, 596
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(1980).

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Since Congress so clearly indicated its understanding of the interrelationship of sections 6229(a) and 6501 in 1992, it seems much more hazardous to ignore the statement as Grapevine asks the Court to do.

E.

Section 6229 Does Not Limit The Issuance of FPAAs or the Adjustment of Partnership Items. Regardless of whether the section 6501(a) limitations period for assessing the Tigues

with 2000 tax is open and suspended, Grapevine argues that "the government has no authority under section 6229 to issue an FPAA for a closed year." Grapevine MSJ Reply Brief at 11. Grapevine's argument fails for one reason: Section 6229 does not authorize or limit the issuance of FPAAs. Even under Grapevine's interpretation, section 6229(a)'s plain language applies to the assessment of tax, not the issuance of FPAAs or the adjustment of partnership items. Grapevine's citation of dicta from Roberts v. Commissioner22 does not support its contrary argument. In Roberts, the IRS issued a notice of deficiency to assess tax related to losses that the taxpayers had received from various partnerships. Since the taxpayers were not personally at risk for the activities generating the losses, the IRS disallowed the losses.23 The IRS conceded that it could not challenge the amount of the partnership losses as part of the personal deficiency proceeding, but it asserted that it could challenge the taxpayer's personal at-risk limits.24 The Tax Court agreed. It held that the at-risk determination was not a partnership item that had to be challenged as part of a partnership-level proceeding.25 Grapevine's case is distinguishable from
22 23 24 25

Roberts v. Commissioner, 94 T.C. 853 (1990). Id. at 858. Id. Id. at 862.
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Roberts. The IRS is not challenging Grapevine's basis within a notice of deficiency proceeding. The IRS properly issued a 1999 FPAA to adjust a 1999 partnership item as part of a 1999 partnership proceeding. Grapevine provides no other authority supporting its argument that the decades of decisions allowing the calculation of closed-year items would not apply to Grapevine's partnership items. Grapevine continues to assert that a record keeping burden distinguishes partnership items from other closed-year items, see Grapevine MSJ Reply at 15, but courts have repeatedly rejected that argument.26 In Siben v. Commissioner, for example, the Second Circuit rejected the taxpayer's assertion that it would be unreasonable to force partners to rely upon partnerships to retain tax records for longer than three years. The Second Circuit pointed out that: "a taxpayer can generally protect himself by taking steps to ensure that the partnership preserves records needed to support the partnership items claimed on the individual partner's returns."27 In addition, none of the burdens cited by Grapevine apply to Grapevine's partners. The 2000 income accrued only one year after the 1999 basis adjustment, and the only two individuals behind all of the relevant shelter entities involved in this case remain the same: Joseph and Virginia Tigue.

See, e.g., Green v. Commissioner, 963 F.2d 783, 789 (5th Cir. 1992) (depending upon another entity to keep preserve tax records "not unfamiliar in the world of tax"); Siben v. Commissioner, 930 F.2d 1034, 1037 (2nd Cir. 1991) (taxpayers can protect themselves by ensuring that partnership preserves records).
27

26

Siben, 930 F.2d at 1037.
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F.

Section 6501(e)'s Six-Year Assessment Period for Substantial Omissions of Income Applies to the Tigues' 1999 Tax Year.

Grapevine's reply to the United States' discussion of section 6501(e)'s six year assessment period attempts to focus the Court's attention on the Tigues' disclosure of proceeds. Those proceeds, however, are only one part of a much larger and complicated scheme that the Tigues' used to reduce their income. To determine whether the Tigues' adequately disclosed this omitted income, the Court must understand and evaluate the entire scheme.

1.

The Tigues Omitted Gain From the Sale of Their Partnership Interests

Grapevine admits that gross income under section 6501(e) is defined as gain from sale instead of proceeds from sale. See Grapevine MSJ Reply at 20 ("In fact, the Supreme Court accepted the Government's definition of gross income as gross receipts minus basis.") Nevertheless, Grapevine asserts the Tigues did not omit gain from the sale of their partnership interests because they reported the correct proceeds along with an erroneous basis amount. See Grapevine MSJ Reply Brief at Part II(F)(1). Even though the Tigues reported a $45,077 loss from the sale of their partnership interests, Grapevine asks this Court to hold that the Tigues did not omit their $9,954,926 of gain. The plain truth is that this gain does not appear anywhere on their return. Grapevine's definition of "omit" does not apply to 6501(e). Regardless of Grapevine's assertions about how the Supreme Court interpreted section 6501's predecessor, section 275,28

28

See Colony, Inc. v. Commissioner, 357 U.S. 28 (1958).
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Grapevine's definition of omit would not make sense when applied to section 6501(e). In particular, accepting Grapevine's definition of omit would render section 6501(e)'s adequate disclosure exemption meaningless. The adequate disclosure exemption would not apply because under Grapevine's theory, it need not disclose how it determined the basis which is one of the two essential elements of calculating the gain; i.e. proceeds less basis equals gain. The Fifth Circuit apparently agreed with this conclusion in Phinney v. Chambers.29 In that case, the taxpayer and her husband held an installment note that they had received in exchange for stock they held as community property.30 When the husband died, the executor of his estate took possession of the entire note under a state law provision that allowed community debts to be paid out of community property.31 While in the estate's possession, the note was paid in full. In accordance with its interpretation of the installment recognition method, the estate prepared a trust return showing the taxpayer's community share of the note payment as proceeds received from the sale of stock. The trust return did not report a gain, however, because it reported a basis in the stock equal to the proceeds.32 Part of this basis apparently originated from a basis step-up that the taxpayer claimed upon her husband's death.33 The IRS subsequently denied this basis step-up and issued a deficiency notice over three years after the taxpayer's trust and individual returns were filed. The IRS asserted that section 6501(e)'s six-year assessment period applied because the taxpayer had substantially omitted her income. The taxpayer, on the

29 30 31 32 33

Phinney v. Chambers, 392 F.2d 680 (5th Cir. 1968). Id. at 681. Id. at 681. Id. at 682. Id. at 684.
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other hand, asserted that no omission occurred. As Grapevine argues in this case, the taxpayer in Phinney relied upon Colony, Inc. v. Commissioner to argue that no "omission" of income can occur where a taxpayer reports the correct amount of proceeds.34 Since her trust return had reported the correct amount of note proceeds, she argued that section 6501(e)'s six-year assessment period did not apply. The Fifth Circuit disagreed because it concluded that "the enactment of [section 6501(e)'s adequate disclosure exemption] makes it apparent that the six year statute is intended to apply where there is either a complete omission of an item or income" or a misstatement "of the nature of an item of income."35 The Fifth Circuit went on to determine that the taxpayer's disclosure of proceeds did not qualify for section 6501(e)'s adequate disclosure exemption.36 Like the taxpayer in Phinney, the Tigues omitted their gain. Grapevine may argue that the Tigues' otherwise adequately disclosed their gain by disclosing proceeds, but that determination is made by analyzing the adequate disclosure exemption's requirements under section 6501(e)(1)(A)(ii), not the definition of omit.

2.

The "Clues" to be Gleaned From the Tigues' Returns Were Incomplete and Misleading

To evaluate whether Grapevine adequately disclosed its omitted income, one must first evaluate the Son of BOSS tax shelter that caused the omission. Grapevine failed to respond to the United States' assertion that the Tigues' participated in a Son of BOSS shelter transaction,

34 35 36

Id. at 683. Id. at 685. Id. at 684-685.
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see Grapevine Response to U.S. Prop. Fact 2, 2(b), but Grapevine's own briefing recognizes the transaction's relevance.37 Grapevine asserts that it disclosed enough capital account activity in its schedules M-1 and K-1 for the IRS to uncover Grapevine's basis adjustment, which according to Grapevine, is "ultimately...the issue in this case." Grapevine MSJ Reply Brief at 28-29. But before one can evaluate whether the disclosed capital account numbers adequately disclosed the basis adjustment, one must understand how the capital account numbers relate to the basis adjustment. One must understand that the capital account activity and basis adjustment are part of a more-complicated Son of BOSS shelter scheme. Instead of viewing the upward basis adjustment in isolation, the Court must consider how all of the scheme's parts helped or hindered disclosure. The Court must consider, for example, whether the scheme's use of LLCs provided a layer of confusion that hindered disclosure. When viewed in the context of Grapevine's Son of BOSS shelter transaction, the inadequacy of Grapevine's alleged "clues" becomes obvious. Grapevine cites's Colony to support the adequacy of its disclosure, see Grapevine MSJ Reply Brief at Part II(F)(2), but Colony's facts are distinguishable. Colony reduced its income by capitalizing simple, common real estate improvement payments related to water and utility costs.38 The Tigues, on the other hand, reduced their income with an economically meaningless shelter transaction involving Treasury bond short sales, partnership contributions, and basis adjustments. Instead of common

Grapevine complains that it cannot respond to the United States' proposed finding because it has not been provided with a Son of BOSS definition. The United States' proposed finding cited, however, the IRS's thorough definition and analysis in IRS Chief Counsel Notice 2003-020, IRS CCN CC-2003-020, available at 2003 WL 24016805 (June 25, 2003).
38

37

See Colony v. Commissioner, 26 T.C. 30, 31 (1965).
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business costs, Grapevine used a complicated personal transaction that lacked economic substance. The IRS is now thoroughly familiar with how these irrational, abusive transactions are executed and reported, but during 1999 and 2000, these transactions were relatively new.39 The disclosure of a simple purchase and sale of treasury securities gave the IRS no hint that the Tigues had not only opened a short sale and then contributed its proceeds to Grapevine, but crucially, they also contributed the obligation to close that short sale. The bare capital activity disclosed in Grapevine's schedules K-1 and M-1 provided the IRS with no reason to suspect that individual taxpayers like the Tigues would use Treasury bond short sales and partnership contributions to manufacture $9,978,119 of basis within 24 hours. The crux of the problem is that the brief increase in basis would be washed out by the obligation to close the sale. If the Tigues had really meant to provide a full disclosure, the they should have provided a complete picture and revealed the obligation to close the short sale. More importantly, the Tigues' alleged disclosures were misleading. The statement in Grapevine's return showing that Grapevine sold the Treasury securities makes it appear that Grapevine opened the short sale instead of the Tigues. Thus, not only did the Tigues not disclose their contribution of the short-sale obligation, Grapevine's return makes it appear that the Tigues never possessed a short-sale obligation to contribute. Grapevine asserts that it does not understand why its disclosure was misleading because, interestingly, it asserts that Grapevine did in fact purchase and sell Treasury securities. See Grapevine MSJ Reply Brief at 29. But if

See IRS Chief Counsel Notice 2003-020, IRS CCN CC-2003-020, available at 2003 WL 24016805 (June 25, 2003) (describing and analyzing a shelter transaction similar to Grapevine's); IRS Notice 2000-44, 2000-36 I.R.B. 255, 2000 WL 1138430 (alerting taxpayers that artificial basis transactions are improper).
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the Tigues actually opened the short sale, Grapevine could not have sold securities. In a short sale, the investor sells securities only once­when it is opened. The investor opens the sale by borrowing securities and selling them. The investor then closes the sale by purchasing securities and returning them to the lender. Thus, a short sale transaction includes only one sale­the opening sale. If the Tigues actually opened the sale, only they would have sold securities, not Grapevine. Thus, their disclosure was inaccurate as well as incomplete. Grapevine's case is more similar to Phinney v. Chambers.40 As discussed above, the taxpayer in that case used a basis step-up to reduce her gain from a stock sale. Just as Grapevine claims in this case, the taxpayer in Phinney claimed that her disclosure of proceeds qualified as an adequate disclosure. The Fifth Circuit disagreed. In particular, the Court held that the taxpayer's disclosures were inadequate because they did not "give the government a chance to challenge" the taxpayer's basis step-up. The court found it important that the government had already challenged the same kind of basis step-up in a previous case. Thus, the court concluded, "[i]t simply defies belief" that the government would not have challenged the step-up if the taxpayer had given the government the opportunity.41 As in Phinney, Grapevine never gave the IRS a chance to challenge its basis adjustment. Instead, it hid the adjustment behind its presentation of an innocent purchase and sale of Treasury securities.

CONCLUSION Section 6229(a) does not impose a limitation upon the Service's ability to assert a tax

40 41

Phinney, 392 F.2d 680. Id. at 685.
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liability against the Tigues arising out of their Son of BOSS tax shelter. The three-year statute of limitations provided by section 6501(a) was open for their 2000 year, permitting the Service to challenge their use of the NOL deduction which should have been used in 1999 since the Son of BOSS transaction in that year was invalid. The six-year statute of limitations in section 6501(e) provides an independent means for asserting a liability against them for their 1999 year. In both situations, the issuance of an FPAA to the Tigues' Grapevine partnership was the first step in this process. This Court should join with the other three courts that have addressed the question of whether section 6229(a) created a new and independent limitation on the examination of partnership returns and respond with the same answer: No. The FPAA was timely; this case should proceed to trial.

Respectfully Submitted,

/s/ Grover Hartt, III GROVER HARTT, III Attorney of Record Tax Division U.S. Department of Justice 717 N. Hardwood, Suite 400 Dallas, Texas 75201 (214) 880-9721 (Main) (214) 880-9741 (Fax) EILEEN J. O'CONNOR Assistant Attorney General MILDRED L. SEIDMAN Chief, Court of Fed. Claims Section CHRISTOPHER R. EGAN DAVID R. HOUSE Of Counsel

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CERTIFICATE OF SERVICE IT IS HEREBY CERTIFIED that service of the foregoing UNITED STATES' REPLY TO PLAINTIFFS' RESPONSE TO CROSS MOTION FOR SUMMARY JUDGMENT has been made on the 29th day of December, 2005, by mailing a copy thereof to: Todd Welty Meadows, Owens, Collier, Reed, Cousins & Blau, L.L.P 901 Main Street, Suite 3700 Dallas, Texas 75202 /s/ Grover Hartt, III GROVER HARTT, III

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