Domulewicz v. Comm'r of Internal Revenue

• Decision Date: 08 August 2007
• Docket Number: No. 10434–05.,10434–05.
• Citation: 129 T.C. No. 3,129 T.C. 11
• Parties: Michael V. DOMULEWICZ and Mary Ann Domulewicz, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Tax Court

129 T.C. 11

129 T.C. No. 3

Michael V. DOMULEWICZ and Mary Ann Domulewicz, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 10434–05.

United States Tax Court.

Aug. 8, 2007.

As part of a Son–of–BOSS transaction designed to create a basis of approximately $29.3 million in publicly traded stock purchased at a relatively minimal cost, P entered into a short sale of U.S. Treasury notes and contributed the proceeds of that sale and the related obligation to a partnership (DIP) in which P was one of three partners. Neither P nor DIP treated the obligation assumed by DIP as a liability under sec. 752, I.R.C., and P did not compute his basis in DIP by taking the obligation into account. After DIP satisfied the obligation and received contributions of the publicly traded stock from its partners, the partners transferred their interests in DIP to DII, an S corporation of which they were shareholders. The transfer of partnership interests was followed by DII's receipt of DIP's distributed assets; i.e., the stock and cash. DII sold the stock and claimed a resulting capital loss of $29,306,024. On Ps' 1999 Federal income tax return, P claimed his $5,858,801 share of the reported loss as a passthrough capital loss from

DII. P claimed that the loss offset a $5,831,772 capital gain that P realized during the year. In an FPAA pertaining to DIP, R determined that the basis of the stock distributed by DIP was zero and that accuracy-related penalties under sec. 6662, I.R.C., applied. When no petition was filed as to the FPAA, R did not assess any tax or accuracy-related penalty as to DII's sale of the stock. Instead, R issued an affected items notice of deficiency to Ps as a predicate to assessing those amounts. Ps now move the Court to dismiss this case for lack of jurisdiction, asserting that the deficiency procedures of subch. B of ch. 63, I.R.C. (deficiency procedures), do not apply to R's disallowance of the passthrough loss or to R's determination of the accuracy-related penalties.

Held: Sec. 6230(a)(2)(A)(i), I.R.C., makes the deficiency procedures applicable to R's disallowance of the passthrough loss from DII.

Held, further, R's determination of the accuracy-related penalties is not subject to the deficiency procedures by virtue of the parenthetical text added to sec. 6230(a)(2)(A)(i), I.R.C., by the Taxpayer Relief Act of 1997, Pub.L. 105–34, sec. 1238(b)(2), 111 Stat. 1026.

David D. Aughtry, Eric M. Nemeth, and Paul L.B. McKenney, for petitioners.

Meso T. Hammoud, for respondent.

OPINION

LARO, Judge.

This is a Son–of–BOSS case that is currently before the Court on petitioners' motion to dismiss for lack of jurisdiction. See generally Kligfeld Holdings v. Commissioner, 128 T.C. 192, (2007), and Notice 2000–44, 2000–2 C.B. 255, for a general description of Son–of–BOSS cases. Petitioners petitioned the Court to redetermine respondent's determination of a $2,398,491 deficiency in their 1999 Federal income tax and a $946,750.80 accuracy-related penalty under section 6662(a).¹ Those determinations were reflected in an affected items notice of deficiency issued to petitioners after no partner of DMD Investment Partners (DIP) timely petitioned the Court with respect to a notice of final partnership administrative adjustment (FPAA) mailed to Michael Domulewicz (petitioner) as DIP's tax matters partner (TMP). Copies of the FPAA also were mailed to each of DIP's other partners.

We decide the following issues: ²

1. Whether section 6230(a)(2)(A)(i) makes the deficiency procedures of subchapter B of chapter 63 (deficiency procedures) applicable to respondent's disallowance of petitioners' claim to a passthrough loss from DMD Investments, Inc. (DII), an S corporation in which petitioner (through his grantor trust) was a 20–percent shareholder.³ Petitioners argue that the deficiency procedures do not apply to this item. Respondent argues to the contrary, asserting that a partner-level determination was required as to this item. We agree with respondent.

2. Whether respondent's determination of the accuracy-related penalties is subject to the deficiency procedures. The parties agree that it is not. So do we.⁴

Background

Petitioners are husband and wife, and they resided in Bloomfield Hills, Michigan, when their petition was filed with the Court. They filed a joint 1999 Form 1040, U.S. Individual Income Tax Return, on or before August 18, 2000.

Petitioner was a 20–percent shareholder of CTA Acoustics (CTA) when CTA was sold on April 30, 1999, at a gain to the shareholders of approximately $30 million. Petitioner's portion of the gain was $5,831,772, and he implemented a plan promoted by BDO Seidman and Jenkens & Gilchrist to create a $5,858,801 “loss” to report as an offset to that gain. As discussed in more detail infra, the “loss” was reportedly generated by using a partnership, an S corporation, and a short sale of U.S. Treasury notes to create a basis of approximately $29.3 million in publicly traded stock purchased at a relatively minimal cost.⁵ The transaction was similar to the transactions described in Notice 2000–44, supra.

Under the plan, DIP was formed on April 30, 1999, with petitioner as a 20–percent partner and two other individuals (at least one of whom was a 40–percent shareholder of CTA) each with a 40–percent interest.⁶ On July 7, 1999, petitioner entered into a short sale of U.S. Treasury notes with a face value of $5,800,000.⁷ The U.S. Treasury notes matured on May 31, 2001, and petitioner sold them on July 7, 1999, for $5,791,057.06 (inclusive of $31,614.75 of accrued interest). On July 8, 1999, petitioner contributed to DIP the proceeds of the short sale, the obligation to satisfy the short sale, and $116,000 in “margin cash”. Neither petitioner nor DIP treated the short sale obligation assumed by DIP as a liability under section 752, and petitioner did not compute his basis in his interest in DIP by taking that obligation into account. On July 14, 1999, DIP satisfied the short sale obligation (as well as similar short sale obligations assumed from DIP's other partners) by purchasing U.S. Treasury notes with a face value of $29,500,000 for $29,402,053.78 plus accrued interest of $186,188.52 and delivering the U.S. Treasury notes in satisfaction of the short sales.

On August 12, 1999, petitioner transferred to DIP 1,500 shares of publicly traded stock in Integral Vision, Inc. (INVI). On August 23, 1999, DIP sold 4,500 of the 7,500 shares of INVI stock contributed by the partners (in addition to 1,500 shares contributed by petitioner, the other two partners of DIP had contributed a total of 6,000 shares) and claimed a short-term capital loss of $2,278. DIP reported as to the claimed loss that the 4,500 shares were purchased on August 11, 1999, at a cost of $10,893 and were sold for $8,615. On August 24, 1999, petitioner transferred his interest in DIP to DII, which had been incorporated approximately 8 months earlier. Petitioner and DII reported that transfer as a nontaxable exchange under section 351, and DII claimed a carryover basis in the transferred partnership interest equal to petitioner's basis in DIP. As a result of this transfer (and similar contemporaneous transfers made by DIP's two other partners), DIP dissolved and all of its assets, including the remaining 3,000 shares of INVI stock, were distributed and received by DII. On DIP's 1999 (final) Form 1065, U.S. Partnership Return of Income, DIP reported for that year that it had realized (1) $1,961 in income, all from tax-exempt interest, and (2) a $110,611 short-term capital loss attributable to the sale of U.S. Treasury notes ($108,333) and the sale of the 4,500 shares of INVI stock ($2,278). DIP also reported that it had paid $167,477 of interest expenses on investment debts and that it had distributed $30,447,106 in cash and/or marketable securities to its partners. Petitioner, as a general partner of DIP, filed DIP's 1999 return no later than April 17, 2000.

At the time of DIP's dissolution, DIP's only assets were the INVI stock and minimal cash. Pursuant to section 732(b), DII claimed a basis in the INVI stock equal to its basis in DIP. On December 30, 1999, DII sold some INVI stock for $5,716 and claimed on its 1999 Form 1120S, U.S. Income Tax Return for an S Corporation, that it had realized on the sale a long-term capital loss of $29,306,024.⁸ DII also claimed an ordinary loss of $1,053,400, resulting from its payment of fees to Jenkens & Gilchrist. As to the claimed losses, an ordinary loss of $210,680 (representing petitioner's share of the fees) and a long-term capital loss of $5,858,801 (representing petitioner's share of the reported capital loss) passed through to petitioner, who claimed them on petitioners' 1999 Federal income tax return. Petitioners claimed on that return that the $5,858,801 long-term capital loss offset a $5,831,772 long-term capital gain that petitioner had realized on April 30, 1999, from his sale of his stock in CTA.

On October 15, 2003, respondent mailed the FPAA for 1999 to petitioner as DIP's TMP. Respondent determined in the FPAA that DIP was not entitled to deduct any of the claimed $110,611 short-term capital loss, that DIP was not entitled to deduct any of the claimed $167,477 of interest expenses, that the basis of the property (other than money) distributed by DIP was zero rather than $30,447,106 as claimed, and that a series of alternative accuracy-related penalties under section 6662 applied. As to these items, respondent determined in the FPAA that: (1) The basis of the property distributed by DIP was zero because DIP failed to substantiate the basis and, alternatively, the outside bases of DIP's partners were not adjusted under section 752 on account of the short sale liability; (2) DIP's claimed short-term capital loss and interest expense were disallowed for lack of substantiation; (3) DIP was a sham and was disregarded, and all transactions it engaged in were...