Monti v. U.S.

Citation223 F.3d 76
Decision Date01 August 1999
Docket NumberDocket No. 97-6215
Parties(2nd Cir. 2000) JOSEPH MONTI and TITA MONTI, Plaintiffs-Appellants, v. UNITED STATES OF AMERICA, Defendant-Appellee
CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)

Appeal from a judgment of the United States District Court for the Eastern District of New York (Joanna Seybert, Judge) granting the government's motion to dismiss for lack of subject matter jurisdiction. We hold that the plaintiffs' action for a federal income tax refund is not attributable to a "partnership item" for purposes of the Tax Equity and Fiscal Responsibility Act of 1982 and that the district court therefore erred in ruling that it had no jurisdiction over the action.

Reversed and remanded.

JOHN W. HUGHES, New York, NY, for Plaintiffs-Appellants.

TERESA T. MILTON, Attorney, Tax Division, Department of Justice, Washington, DC (Loretta C. Argett, Assistant Attorney General, Washington, DC, and Teresa E. McLaughlin, Attorney, Tax Division, Department of Justice, Washington, DC, on the brief; Zachary W. Carter, then-United States Attorney for the Eastern District of New York, of counsel), for Defendant-Appellee.

Before: McLAUGHLIN, SACK, and KATZMANN, Circuit Judges.

SACK, Circuit Judge:

The question presented by this appeal is whether a partner's claim for tax treatment consistent with that accorded other partners in a settlement with the Internal Revenue Service is a claim for a refund attributable to a "nonpartnership item" that properly can be the subject of a suit in a federal district court, or is a claim for a refund attributable to a "partnership item" about which suit in federal district court is barred. We hold that it is attributable to a nonpartnership item and that this action asserting such a claim was therefore properly instituted in the district court.

Plaintiffs-Appellants Joseph and Tita Monti, a married couple, appeal from the dismissal of their federal income tax refund action by the United States District Court for the Eastern District of New York (Joanna Seybert, Judge). The district court held that it lacked jurisdiction over the Montis' claim because the United States has not waived sovereign immunity for refund claims attributable to "partnership items" except in very limited circumstances not applicable to the Montis' case. We hold that a refund action based on the Internal Revenue Service's failure to offer consistent settlement terms to nonsettling partners of a partnership is not attributable to a "partnership item" for purposes of the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), Pub. L. No. 97-248, 96 Stat. 324, and that the United States has therefore waived sovereign immunity with respect to such an action. Accordingly, we reverse and remand the case to the district court for adjudication of the Montis' refund action on the merits.

BACKGROUND
Overview

The Montis were limited partners in a partnership named Syn-Fuel Associates ("Syn-Fuel"). They claimed individual federal income tax deductions based on their partnership interests in Syn-Fuel for the years 1982 through 1985. In 1987 the Internal Revenue Service (the "IRS") audited Syn-Fuel pursuant to the provisions of TEFRA and, in a Final Partnership Administrative Adjustment ("FPAA"), disallowed many of the deductions. Syn-Fuel appealed the FPAA to the United States Tax Court, where it was affirmed. See Peat Oil and Gas Assocs. v. Commissioner, 100 T.C. 271 (1993). This Court then affirmed the Tax Court's ruling in Ferguson v. Commissioner, 29 F.3d 98 (2d Cir. 1994) (per curiam).

When the IRS enters into a settlement agreement regarding partnership taxes with one partner, it is required by TEFRA to "offer to any other partner who so requests[,] settlement terms... which are consistent with those contained in [the] settlement agreement." I.R.C.§6224(c)(2). During the preparation of the FPAA and the subsequent litigation, many individual Syn-Fuel partners settled with the IRS. The Montis did not. The Montis' tax treatment was therefore resolved through the FPAA and the subsequent litigation. They have paid the taxes assessed to them according to the FPAA, but are now suing for a refund reflecting the consistent treatment that they assert is due to them.

In seeking a refund, the Montis allege that they were never given the statutorily required notice of the terms of one of the settlements entered into by several limited partners (the "Craig Settlement"), that the time during which they were required to file for treatment equivalent to that given to other Syn-Fuel partners under the Craig Settlement therefore never began to run, and that their current request for settlement terms consistent with the Craig Settlement therefore remains timely. The terms of the Craig Settlement are far more favorable to the Montis than those resulting from the FPAA and the subsequent related litigation.

Sovereign Immunity

The doctrine of sovereign immunity prevents suits against the United States unless the United States has waived the immunity. See United States v. Testan, 424 U.S. 392, 399 (1976). The government has done so broadly with respect to federal income tax refund actions. See 28 U.S.C. §1346(a)(1); United States v. Forma, 42 F.3d 759, 763 (2d Cir. 1994). There are certain kinds of refund actions, however, with respect to which the government has not waived sovereign immunity. Relevant here: "No action may be brought for a refund attributable to partnership items (as defined in [I.R.C.] section 6231(a)(3)) except as provided in section 6228(b) or section 6230(c)." I.R.C. §7422(h). Thus, if the refund the Montis seek is attributable to a partnership item other than those excepted by the statute, their action was correctly dismissed by the district court.

Statutory Framework Under TEFRA

Partnerships are generally not taxable entities. "[T]he income and expenses of the partnership normally 'flow through' to the several partners, who remain ultimately responsible for filing their own taxes." Transpac Drilling Venture 1982-12 v. Commissioner, 147 F.3d 221, 223 (2d Cir. 1998). Until the enactment of TEFRA in 1982, administrative and judicial proceedings related to partnership income were therefore conducted at the level of the individual partner. If the IRS took issue with the partnership's books or returns, it addressed the issue with each partner individually. See Chimblo v. Commissioner, 177 F.3d 119, 121 (2d Cir. 1999).

Because this system proved inefficient and often led to inconsistent results, "[u]nder TEFRA, one proceeding determines how partnership items will be reported on all of the partners' individual returns. The statute requires partners, on their personal returns, to treat partnership items consistently with the items' treatment on the partnership return." Olson v. United States, 37 Fed. Cl. 727, 731 (1997), aff'd, 172 F.3d 1311 (Fed. Cir. 1999). Individual taxpayers still pay the relevant taxes -- the partnership does not pay income tax -- but determinations as to the amount of tax attributable to partnership items are made at the partnership level. See Randell v. United States, 64 F.3d 101, 103-04 (2d Cir. 1995), cert. denied, 519 U.S. 815 (1996).

TEFRA defines a partnership item as follows:

The term "partnership item" means, with respect to a partnership, any item required to be taken into account for the partnership's taxable year under any provision of subtitle A to the extent regulations prescribed by the Secretary provide that, for purposes of this subtitle, such item is more appropriately determined at the partnership level than at the partner level.

I.R.C. §6231(a)(3). A "nonpartnership item" is defined as "an item which is (or is treated as) not a partnership item." I.R.C. §6231(a)(4).

If the IRS decides to examine a partnership's tax return, each partner can opt either to participate in the proceeding or seek to settle. Absent a settlement with all the partners, the proceeding results in an FPAA that must be sent to the partnership's Tax Matters Partner ("TMP") and to all "notice partners" who, because of the magnitude of their interest in the partnership are, by statute, entitled to direct notice from the IRS. See I.R.C. §6223(a)(2). The TMP is responsible for notifying non-notice partners, such as the Montis, of the FPAA. The FPAA may then be appealed by the TMP or any notice partner to the Tax Court, a federal district court, or the Court of Claims, see Chimblo, 177 F.3d at 121, with all other partners who have not settled being treated as parties to such an action, see I.R.C. §6226(c). Unless a partner has opted out of the FPAA process by settling, that partner is bound by the results of this process. Because the FPAA determines the tax treatment of partnership items, a partner cannot bring a refund action attributable to anything litigated during the FPAA process. Allowing such lawsuits would undercut TEFRA's goal of consolidating the treatment of partnership items at the partnership level. See Kaplan v. United States, 133 F.3d 469, 473 (7th Cir. 1998) ("TEFRA requires that all challenges to adjustments of partnership items be made in a single, unified agency proceeding; indeed, this is the key component of TEFRA that yields the desired benefits of economy and consistency.").1

A partner who settles with the IRS under I.R.C. §6224(b) thereby removes him or herself from the partnership-level FPAA proceedings. But the Internal Revenue Code provides that if the IRS enters into such a settlement with one or more partners, it is required to "offer to any other partner who so requests[,] settlement terms . . . which are consistent with those contained in [the] settlement agreement." I.R.C. §6224(c)(2). In other words, the IRS cannot play favorites; if one partner settles, it must offer the same settlement terms to all partners. If the IRS does settle the tax liability of a partner it must, under...

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