581 F.3d 297 (6th Cir. 2009), 08-1598, Desmet v. C.I.R.
|Docket Nº:||08-1598, 08-1676.|
|Citation:||581 F.3d 297|
|Opinion Judge:||JULIA SMITH GIBBONS, Circuit Judge.|
|Party Name:||Daniel J. DESMET, Linda K. Desmet (08-1598); Michael V. Domulewicz, Mary Ann Domulewicz (08-1676), Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.|
|Attorney:||David D. Aughtry, Chamberlain, Hrdlicka, White, Williams, & Martin, Atlanta, Georgia, for Appellants. Michael J. Haungs, United States Department of Justice, Washington, D.C., for Appellee. David D. Aughtry, Chamberlain, Hrdlicka, White, Williams, & Martin, Atlanta, Georgia, for Appellants. Micha...|
|Judge Panel:||Before CLAY and GIBBONS, Circuit Judges; GREER, District Judge. [*]|
|Case Date:||September 17, 2009|
|Court:||United States Courts of Appeals, Court of Appeals for the Sixth Circuit|
Argued: March 10, 2009.
[Copyrighted Material Omitted]
In these consolidated appeals, petitioners-appellants Daniel J. Desmet, Linda K. Desmet, Michael V. Domulewicz, and Mary Ann Domulewicz appeal orders of the United States Tax Court assessing income tax deficiencies of $2,497,934 against the Desmets and $1,250,099 against the Domulewiczes for the 1999 tax year. The petitioners do not dispute the amounts owed, but they argue that the tax court lacked jurisdiction to determine the deficiencies. For the reasons that follow, we find that the tax court had jurisdiction over the deficiency proceedings, but we remand for consideration of whether certain components of the deficiencies were time-barred.
Daniel and Michael were business partners in a venture known as CTA Acoustics. They sold the company in 1999 at a gain to the shareholders of approximately $30 million-including approximately $12 million to Daniel and $6 million to Michael. To eliminate their tax liability from the sale, the partners engaged in a series of transactions which, taken together, formed an abusive tax shelter known as " Son-of-BOSS." See I.R.S. Notice 2000-44, 2000-2 C.B. 255. A typical Son-of-BOSS scheme " uses a series of contrived steps in a partnership interest to generate artificial tax losses designed to offset income
from other transactions." Kornman & Assocs., Inc. v. United States, 527 F.3d 443, 446 n. 2 (5th Cir.2008) (internal quotation marks omitted). " Enormous losses are attractive to a select group of taxpayers-those with enormous gains." Kligfeld Holdings v. Commissioner, 128 T.C. 192, 194, 2007 WL 1556083 (2007).
In this case, the " contrived steps" may be summarized as follows. First, in April 1999, Daniel and Michael formed a partnership known as DMD Investment Partners (the " partnership" ), with each holding a share of the partnership equivalent to his share in CTA Acoustics. They then executed a short sale of United States Treasury notes, generating a loss of approximately $29 million. Next, Daniel and Michael transferred shares of Integral Vision, Inc. (" INVI" ), a publicly traded company, to the partnership; the partnership later sold 4,500 of the 7,500 shares it held. Meanwhile, Daniel and Michael also formed an S corporation, DMD Investments, Inc. (the " S corporation" 1). Each transferred his interest in the partnership to the S corporation. The remaining 3,000 shares of INVI stock held by the partnership were distributed to the S corporation. As a result of these transfers, no shares or assets remained in the partnership, and the partnership therefore dissolved. In December 1999, the S corporation sold the 3,000 shares of INVI stock and claimed a loss of approximately $29 million.
The partnership and the S corporation both filed informational tax returns for 1999. The partnership reported distributions totaling $30.4 million, and the S corporation reported a long-term capital loss of $29.3 million. Daniel and Michael, together with their wives Linda and Mary Ann, respectively, also filed income tax returns for that year. On these returns, the petitioners claimed capital losses passing through from the S corporation, offsetting the capital gains they had realized from the sale of CTA Acoustics. By setting off their capital gains against the reported losses, the petitioners avoided paying income taxes on the gains. The petitioners also claimed ordinary losses passing through from the S corporation of more than $1 million, which represented fees paid to the law firm of Jenkens & Gilchrist for structuring the transactions.
The Internal Revenue Service (" IRS" ) determined that the partnership had claimed distributions of more than $30 million without reporting related contingent obligations, namely, the obligation to satisfy the short sale of the United States Treasury notes. According to the IRS, the partnership's distributions and obligations cancelled each other out. Consequently, on October 15, 2003, the IRS issued a notice of Final Partnership Administrative Adjustment (" FPAA" ) to the partnership. The FPAA adjusted the basis 2 of the property distributed by the partnership from $30.4 million-as reported on the partnership's 1999 informational return-to zero. Neither Daniel nor Michael contested the FPAA, and it became final. See I.R.C. § 6225(a)
On March 10, 2005, the IRS issued notices of income tax deficiency to the petitioners relating to their 1999 returns. The
IRS determined that, because the partnership's basis was zero, the petitioners also held a zero basis in their shares of the partnership. Accordingly, the IRS did not permit any of the loss deductions that petitioners claimed on their personal returns. The IRS also disallowed the claimed losses stemming from the Jenkens & Gilchrist fees. All told, the IRS found that the Desmets owed $4,797,388.00 in taxes and $1,891,429.60 in penalties and that the Domulewiczes owed $2,398,491.00 in taxes and $946,750.80 in penalties.
The Desmets and the Domulewiczes separately filed petitions in the United States Tax Court seeking redetermination of the deficiencies on June 7, 2005. The practical effect of the petitions was to prevent the IRS from collecting the taxes and penalties while the deficiency proceedings were pending. However, the petitioners did not dispute the underlying transactions. Rather, they argued that they were not liable because Daniel and Michael engaged in the challenged transactions on the advice of counsel and because Linda and Mary Ann had no knowledge of the transactions.
Almost one year after filing the petitions, the petitioners moved to dismiss the redetermination actions for lack of jurisdiction in the tax court. Before the court ruled on the motions to dismiss, the petitioners filed a second round of dispositive motions identified as " protective" motions for summary judgment. As in their motions to dismiss, the petitioners argued that the tax court lacked jurisdiction to redetermine the tax deficiencies. They also contended that the IRS's disallowance of the claimed losses related to the Jenkens & Gilchrist fees was time-barred. The tax court apparently denied the " protective" motions for summary judgment without opinion on February 15, 2007.
On August 8, 2007, the tax court denied the petitioners' previously filed motions to dismiss, finding that it had jurisdiction over the proceedings. The tax court declined to address the petitioners' argument that the disallowance of the Jenkens & Gilchrist fees was time-barred. Following the denial of the motions to dismiss, the parties signed stipulated decisions finding a deficiency of $2,497,934 for the Desmets and $1,250,099 for the Domulewiczes. Both the Desmets and the Domulewiczes timely appealed. We consolidated the cases for review.
Whether the tax court had jurisdiction is a question of law, which we review de novo. Harbold v. Commissioner, 51 F.3d 618, 621 (6th Cir.1995).
A partnership, unlike a corporation, is not a taxable entity. See I.R.C. § 701. Rather, its tax obligations pass through to the individual partners, who pay them in the form of income tax on a pro rata basis. See Cent. Valley AG Enters. v. United States, 531 F.3d 750, 755 (9th Cir.2008). Before 1982, questions about the tax treatment of partnership income were resolved in separate proceedings against each partner. " This procedure imposed an administrative burden on the IRS, led to duplicative audits and litigation, and created the risk of inconsistent treatment of different partners in the same partnership." Adams v. Johnson, 355 F.3d 1179, 1186 (9th Cir.2004). Under the Tax Equity and Fiscal Responsibility Act of 1982 (" TEFRA" ), Pub.L. No. 97-248, 96 Stat. 324, tax treatment of all " partnership items" is now resolved in a single proceeding against the partnership. See Katz v. Commissioner, 335 F.3d 1121, 1123-24 (10th Cir.2003).
The key change wrought by TEFRA is that tax treatment of all so-called " partnership items" must be determined at the partnership level, not at the partner level. See I.R.C. § 6221; Monti v. United States, 223 F.3d 76, 78-79 (2d Cir.2000). Under TEFRA, a partnership must file an annual informational tax return reporting " partnership items" such as income, loss, deductions, and credits. I.R.C. § 6031(a); Treas. Reg. § 301.6231(a)(3)-1(a)(1)(i). Partners must then treat " partnership items" on their own returns consistently with the treatment of those items on the partnership return. I.R.C. § 6222(a). If the IRS disagrees with the reporting of a " partnership item," it must initiate an administrative proceeding against the partnership, not the partners. I.R.C. § 6223(a)(1). Conversely, if a partner's tax liability stems from nonpartnership items, the IRS may initiate deficiency proceedings against that partner...
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