Alpha I, L.P. v. United States

• Decision Date: 15 June 2012
• Docket Number: Nos. 2011–5024,2011–5030.,s. 2011–5024
• Citation: 109 A.F.T.R.2d 2012,682 F.3d 1009
• Court: U.S. Court of Appeals — Federal Circuit
• Parties: ALPHA I, L.P., (by and through Robert SANDS, a Notice Partner), Beta Partners, L.L.C., (by and through Robert Sands, a Notice Partner), R, R, M & C Partners, L.L.C., (by and through R, R, M & C Group, L.P., a Notice Partner), R, R, M & C Group L.P., (by and through Robert Sands Charitable Remainder Unitrust—2001, a Notice Partner), CWC Partnership I, (by and through Trust FBO Zachary Stern U/A Fifth G. Andrew Stern and Marilyn Sands, Trustees, a Notice Partner), Mickey Management, L.P., (by and through Marilyn Sands, a Notice Partner), M, L, R & R, (by and through Richard E. Sands, Tax Matters Partner), Plaintiffs–Cross Appellants, v. UNITED STATES, Defendant–Appellant.

682 F.3d 1009

109 A.F.T.R.2d 2012-2548

ALPHA I, L.P., (by and through Robert SANDS, a Notice Partner), Beta Partners, L.L.C., (by and through Robert Sands, a Notice Partner), R, R, M & C Partners, L.L.C., (by and through R, R, M & C Group, L.P., a Notice Partner), R, R, M & C Group L.P., (by and through Robert Sands Charitable Remainder Unitrust—2001, a Notice Partner), CWC Partnership I, (by and through Trust FBO Zachary Stern U/A Fifth G. Andrew Stern and Marilyn Sands, Trustees, a Notice Partner), Mickey Management, L.P., (by and through Marilyn Sands, a Notice Partner), M, L, R & R, (by and through Richard E. Sands, Tax Matters Partner), Plaintiffs–Cross Appellants,

v.UNITED STATES, Defendant–Appellant.

Nos. 2011–5024, 2011–5030.

United States Court of Appeals, Federal Circuit.

June 15, 2012.

Thomas A. Cullinan, Sutherland Asbill & Brennan LLP, of Atlanta, GA, argued for plaintiffs-cross appellants. With him on the brief were N. Jerold Cohen and Joseph M. Depew; and Kent L. Jones, of Washington, DC.

Francesca U. Tamami, Attorney, Tax Division, United States Department of Justice, of Washington, DC, argued for defendant-appellant. With her on the brief were Gilbert S. Rothenberg, Acting Deputy Assistant Attorney General, and Kenneth L. Greene, Attorney.

Before RADER, Chief Judge, NEWMAN, and O'MALLEY, Circuit Judges.

O'MALLEY, Circuit Judge.

The U.S. Court of Federal Claims dismissed the Internal Revenue Service's determination that certain taxpayers' transfers of their partnership interests to trusts were shams because the court believed it lacked jurisdiction to address the IRS's determination at the partnership level. The United States appeals that ruling in Case No. 2011–5024. We reverse the Court of Federal Claims's dismissal. The identity of the true partners in the partnership at issue appropriately is determined at the partnership level because, on the particular facts of this case, partnership identity could affect the distributive shares reported to the partners.

After this action commenced, the taxpayers conceded certain capital gain and loss adjustments imposed by the IRS and moved for summary judgment on the valuation misstatement penalties that the IRS sought as a result of those adjustments. The taxpayers argued that their concession of the IRS's adjustments rendered the valuation misstatement penalties moot. The Court of Federal Claims agreed, granted summary judgment to the taxpayers, and declined to impose the valuation misstatement penalties. The United States appeals that ruling in Case No. 2011–5024. We vacate that judgment because the Court of Federal Claims failed to determine whether the taxpayers' underpayment of tax was attributable to the alleged valuation misstatement.

Finally, the Court of Federal Claims granted the government's motion for summary judgment with respect to additional penalties for negligence, substantial understatement, and failure to act reasonably and in good faith, and imposed a twenty-percent penalty on the taxpayers. The taxpayers appeal that ruling in Case No.2011–5030. We dismiss the taxpayers' appeal as premature. If the Court of Federal Claims concludes on remand that the forty-percent valuation misstatement penalty applies, that valuation misstatement penalty could render moot the propriety of the twenty-percent penalty that is the subject of the taxpayers' cross appeal.

I

This case arises from two so-called “Son–of–BOSS” transactions, as well as a transaction involving charitable remainder unitrusts (“CRUTs”), conducted by the heirs of the late Marvin Sands, the founder of Constellation Brands, Inc. In a Son–of–BOSS transaction, a taxpayer attempts to realize tax benefits by transferring assets encumbered by significant liabilities to a partnership in an attempt to increase the partner's basis in the partnership. See Stobie Creek Invs. LLC v. United States, 608 F.3d 1366, 1368–71 (Fed.Cir.2010); Kornman & Assocs. v. United States, 527 F.3d 443, 446 n. 2 (5th Cir.2008). Normally, when a partner contributes property to a partnership, the partner's basis in the partnership increases, and when the partnership assumes a partner's liability, the partner's basis decreases. SeeI.R.C. §§ 722, 733, 752, 754. A Son–of–BOSS transaction recognizes a partnership's acquisition of a partner's asset (here, short-sale proceeds), and disregards the partnership's acquisition of an essentially offsetting liability (here, the obligation to close out the short-sale position). See Stobie Creek Invs., 608 F.3d at 1368–69;Kornman & Assocs., 527 F.3d at 446 n. 2. By employing this strategy, the taxpayer attempts to generate a tax loss or reduce the gain that would otherwise result from the sale of an asset. Id.

In this case, Marvin Sands's heirs owned stock in Constellation. In the first Son–of–BOSS transaction, they used several partnerships to convert approximately $66 million in taxable gain that they anticipated receiving from the sale of their stock into large capital losses. The heirs also prearranged for their partnership interests to be held temporarily by tax-exempt CRUTs at the time of the sale so that, as the government alleges, any gain that might be recognized from the sale would escape taxation. The CRUTs were terminated shortly after they were formed, and the assets of the CRUTs, including the sale proceeds, were distributed to the heirs, purportedly tax free. In the second Son–of–BOSS transaction, the heirs sought to generate significant capital losses to offset other income, again through the use of various partnerships.

In notices of final partnership administrative adjustment (“FPAAs”) issued to the partnerships involved in the Son–of–BOSS transactions, the IRS determined that the transactions should be disregarded and that the transfers of the partnership interests to the CRUTs were shams. The IRS also asserted various basis and capital gain and loss adjustments, as well as several alternative penalties, including a forty-percent penalty for gross valuation misstatement, a twenty-percent penalty for substantial understatement of tax, and a twenty-percent penalty for negligence. The IRS also asserted that the transactions did not increase the partners' amounts at risk under I.R.C. § 465.

The partnerships involved in the Son–of–BOSS transactions initially challenged the IRS's adjustments to the basis, capital gain, and capital loss calculations. In an amended complaint, however, the partnerships conceded the capital gain and loss adjustments on the purported basis of I.R.C. § 465. The Court of Federal Claims later agreed with the partnerships that, because the adjustments had been conceded on the basis of I.R.C. § 465, the forty-percent gross valuation misstatement penalty sought by the IRS because of the adjustments was inapplicable. The Court of Federal Claims also held that the identity of a partnership's partners is a non-partnership item that cannot be addressed in a partnership proceeding, such that it could not consider whether the transfers of the partnership interests to the CRUTs were shams. Finally, the Court of Federal Claims determined that the twenty-percent penalties for substantial understatement of tax and negligence applied and imposed such a penalty on the taxpayers.

A

During 2001 and 2002, the years at issue, Constellation was a leading producer and marketer of alcoholic beverages in North America and the United Kingdom, with gross sales exceeding $3 billion in fiscal year 2001. Constellation was founded and owned by the late Marvin Sands. After his death, the following family members held a controlling interest in Constellation through stock ownership: Marvin's sons, Robert and Richard Sands; his wife, Marilyn Sands; and two trusts established for the benefit of his grandchildren, Abigail Stern and Zachary Stern (the “Children's Trusts”). The government claims that, in 2001, the heirs' stock was worth more than $75 million and had a tax basis of approximately $9 million.

The heirs received tax advice from The Heritage Organization, LLC, which designed and directed the implementation of the two Son–of–BOSS transactions. The heirs implemented the first Son–of–BOSS transaction as follows. Between August 21 and 23, 2001, they established brokerage accounts with Paine Webber. Through those accounts, they collectively sold short approximately $85.6 million of U.S. Treasury Notes.¹ On August 27, 2001, the Children's Trusts assigned their portion of the short-sale proceeds and the obligation to close out the short sale to CWC Partnership I (“CWC”), a preexisting family investment partnership. On August 28, 2001, the heirs and CWC contributed (i) the proceeds from the short sale, (ii) the obligation to close out the short sale, and (iii) a total of 2,000,000 shares of Constellation stock to R, R, M & C Group, L.P. (“RRMC Group”), a new partnership created at the direction of Heritage. The general partner of RRMC Group was R, R, M & C Management Corporation (“RRMC Corp.”), an entity created by Richard and Robert on August 23, 2001. For its claimed 0.1% interest in RRMC Group, RRMC Corp. contributed 2,002 shares of Constellation stock to the partnership.

On August 31, 2001, RRMC Group, in turn, contributed the Constellation stock, the short-sale proceeds, and the obligation to close out the short sale to R, R, M & C Partners, L.L.C. (“RRMC Partners”), another new entity established at the direction of Heritage. RRMC Group held a 99.7163% interest in RRMC Partners. The remaining interest was held by Gloria Robinson, the mother of the heirs' accountant.

On September 6, 2001, RRMC Partners closed out the short-sale position at a net loss of $425,565. On September 10, 2001, RRMC Group purchased Robinson's interest in RRMC Partners, thereby effecting a termination of RRMC Partners. The government alleges that, as a result of this transaction, RRMC Group claimed that its basis in the Constellation stock increased by approximately $85.6...