Duffie v. US

• Decision Date: 10 March 2010
• Docket Number: No. 08-20708.,08-20708.
• Citation: 600 F.3d 362
• Parties: John C. DUFFIE; Melissa Duffie, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

600 F.3d 362

John C. DUFFIE; Melissa Duffie, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.

No. 08-20708.

United States Court of Appeals, Fifth Circuit.

March 10, 2010.

Thomas E. Redding (argued), Sallie W. Gladney, Teresa Jean Womack, Redding & Associates, P.C., Houston, TX, for Plaintiffs-Appellants.

Arthur Thomas Catterall (argued), Michael J. Haungs, Dept. of Justice, Tax Div. Appellate Section, Washington, DC, Michael D. Powell, Dept. of Justice, Tax Div., Dallas, TX, for Defendant-Appellant.

Before KING, JOLLY and STEWART, Circuit Judges.

CARL E. STEWART, Circuit Judge:

John and Melissa Duffie appeal the district court's grant of summary judgment in their tax refund suit. We affirm.

A district court's grant of summary judgment is reviewed de novo, applying the same standard as the district court. Kornman & Assocs. v. United States, 527 F.3d 443, 450 (5th Cir.2008). This court reviews findings of fact for clear error and legal issues de novo. Houston Exploration Co. v. Halliburton Energy Servs., Inc., 359 F.3d 777, 779 (5th Cir.2004). Specifically, a district court's characterization of a transaction for tax purposes is a question of law subject to de novo review, but the particular facts from which that characterization is made are reviewed for clear error. See Compaq Computer Corp. v. Comm'r, 277 F.3d 778, 780 (5th Cir. 2001) (citing Frank Lyon Co. v. United States, 435 U.S. 561, 581 n. 16, 98 S.Ct. 1291, 55 L.Ed.2d 550 (1978)).

We have reviewed the applicable law, the appellate briefs of the parties, the record on appeal, and the district court's opinion. We have further considered the contentions of the parties presented at oral argument. We are convinced that the district court correctly decided the issues in this appeal in its thorough and thoughtful opinion, which we attach hereto and adopt as the opinion of this court. See Keener v. United States, 551 F.3d 1358 (Fed.Cir.), cert. denied, ___ U.S. ___, 130 S.Ct. 153, 175 L.Ed.2d 38 (2009). The judgment of the district court is therefore AFFIRMED.

APPENDIX

IN THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF TEXAS HOUSTON DIVISION JOHN C. and MELISSA DUFFIE, Plaintiffs VS UNITED STATES OF AMERICA, Defendant CIVIL ACTION NO. H-06-2870.

MEMORANDUM AND OPINION

Lee H. Rosenthal, Judge.

In this tax refund suit, the plaintiffs, John Duffie and Melissa Duffie, allege that the Internal Revenue Service improperly assessed enhanced or penalty interest against them under 26 U.S.C. § 6621(c). That statute, which was effective for only a few years, provides for interest at 120% of the statutory interest rate when there is a substantial underpayment of taxes attributable to a tax-motivated transaction.

John Duffie became a limited partner in American Agri-Corp, Inc. ("AMCOR") in 1984. His proportionate share of the partnership's income loss was reported on the Duffies' 1984 joint income tax return. The IRS subsequently disallowed AMCOR expense deductions for tax year 1984, reducing the partnership's loss. As a result, partners, including the Duffies, had underpaid their income tax liability for 1984. The IRS assessed enhanced interest against the Duffies under Section 6621(c) for the underpayment. The Duffies seek a refund.

The parties have filed cross-motions for summary judgment. The Duffies seek summary judgment that as a matter of law, imposing the Section 6621(c) enhanced or penalty rate of interest was erroneous because it is based on a Tax Court judgment entered after a settlement of partnership-level items that did not decide partner-level issues critical to assessing the interest. The government asserts that the Duffies' claims are barred by res judicata and that this court lacks subject-matter jurisdiction over the refund claim because it would require the court to reexamine the partnership items resolved in the Tax Court.

Based on a careful review of the motions, the pleadings, the record, and the applicable law, this court denies the Duffies' motion for summary judgment and grants the government's cross-motion. Final judgment dismissing this case is entered by separate order. The reasons for this ruling are set forth in detail below.

I. Background

A. The Tax Equity and Fiscal Responsibility Act of 1982

Partnerships file informational tax returns, but partnerships are not subject to federal income taxes. 26 U.S.C. § 701. Instead, a partnership is treated as a conduit through which income passes to its partners, who are responsible for reporting their pro rata share of tax on their individual income tax returns. Id.

Before 1982, examining a partnership for federal tax purposes was a tedious process. A partnership filed an informational tax return on a Form 1065, which reflected the distributive shares of partnership income, gains, deductions, and credits attributable to the partners. If the IRS sought to adjust an item on a partnership return, the IRS had to examine each partner's individual return. As a result, the IRS could not ensure consistent adjustments of partnership items among partners. In response, Congress enacted the Tax Equity and Fiscal Responsibility Act of 1982, Pub.L. No. 97-248, 96 Stat. 324, 648-671 ("TEFRA").

TEFRA consolidated the partnership-level audit and adjustment procedures by requiring that "the tax treatment of any partnership item shall be determined at the partnership level." 26 U.S.C. § 6221. TEFRA "created a single unified procedure for determining the tax treatment of all partnership items at the partnership level, rather than separately at the partner level." In re Crowell, 305 F.3d 474, 478 (6th Cir.2002). After TEFRA, the IRS could adjust partnership items "at a singular proceeding, and then subsequently assess all of the partners based upon the adjustment to that particular item. The IRS would not have to conduct individual `partner level' proceedings for each member of a partnership." Prati v. United States, 81 Fed.Cl. 422, 427 (Fed.Cl.2008).

TEFRA defines a "partnership item" as "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 subtitle F, such item is more appropriately determined at the partnership level than at the partner level." 26 U.S.C. § 6231(a)(3). The regulations provide that items "more appropriately determined at the partnership level" include the gains, losses, deductions, and credits of a partnership. 26 C.F.R. § 301.6231(a)(3)-1. The term "partnership item" also "includes the accounting practices and the legal and factual determinations that underlie the determination of the amount, timing, and characterization of items of income, credit, gain, loss, deduction, etc." 26 C.F.R. § 301.6231(a)(3)-1(b).

A "nonpartnership item" is "an item which is (or is treated as) not a partnership item." 26 U.S.C. § 6231(a)(4). The tax treatment of nonpartnership items requires partner-specific determinations that must be made at the individual partner level. See Crnkovich v. United States, 202 F.3d 1325, 1328-29 (Fed.Cir.2000).

TEFRA also includes a hybrid category of "affected items." An "affected item" is "any item to the extent such item is affected by a partnership item." 26 U.S.C. § 6231(a)(5). For example, a taxpayer-partner's medical expense deduction under 26 U.S.C. § 213(a) is an "affected item." Because a taxpayer can only deduct medical expenses to the extent those expenses exceed 7.5% of adjusted gross income, a change in the partnership's income affects the amount of the partner's deduction. Affected items can have both partnership-item and nonpartnership-item components. For example, determining a limited partner's "amount at risk" for purposes of 26 U.S.C. § 465 may require a partnership-item determination of the amount of partnership debt and a nonpartnership-item determination of the amount of that debt assumed by the limited partner.

There are two different types of affected items. "The first type of affected items requires only a computational adjustment at the partner level, which can only be made at the conclusion of the partnership level proceeding." Woody v. Comm'r of Internal Revenue, 95 T.C. 193, 201-02, 1990 WL 121140 (1990) (citing N.C.F. Energy Partners v. Comm'r of Internal Revenue, 89 T.C. 741, 744, 1987 WL 45298 (1987)). "The term `computational adjustment' means the change in the tax liability of a partner which properly reflects the treatment under this subchapter of a partnership item." 26 U.S.C. § 6231(a)(6). "A computational adjustment may include a change in tax liability that reflects a change in an affected item where that change is necessary to properly reflect the treatment of a partnership item." 26 C.F.R. § 301.6231(a)(6)-1T(a). Such a "computational affected item" may be applied to the individual partner without any factual determination at the partner level. "The other type of affected item is one that is dependent upon factual determinations (other than a computation) relating to an adjustment made at the partner level." Woody, 95 T.C. at 202; N.C.F. Energy Partners, 89 T.C. at 744-75. These affected items require fact-finding particular to the individual partner.

If the IRS decides to adjust any partnership items on a partnership's informational income tax return, it must notify the individual partners of the adjustment by issuing a Notice of Final Partnership Administrative Adjustment ("FPAA"). 26 U.S.C. § 6223; see also Kaplan v. United States, 133 F.3d 469, 471 (7th Cir.1998). A Notice of FPAA sets out the proposed adjustments, e.g. disallowing all or part of partnership's deductions, and lists the grounds for the adjustments. Id. For ninety days after a Notice of FPAA issues, the Tax Matters Partner¹ has the exclusive right to challenge the proposed adjustments in Tax Court, the Court of Federal Claims, or a United States District Court. 26 U.S.C. §...