Callaway v. Comm'r of Internal Revenue

• Decision Date: 01 August 1999
• Docket Number: Docket No. 99-4022
• Citation: 231 F.3d 106
• Parties: (2nd Cir. 2000) ELIZABETH N. CALLAWAY, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee
• Court: U.S. Court of Appeals — Second Circuit

Page 106

231 F.3d 106 (2nd Cir. 2000)

ELIZABETH N. CALLAWAY, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Docket No. 99-4022

August Term, 1999

UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT

Argued: September 16, 1999

Decided: September 18, 2000

Appeal from the Tax Court. Taxpayer's deceased spouse held partnership interest. Following TEFRA audit of partnership return, IRS assessed taxes attributable to spouse's distributive share of disallowed losses by computational adjustment. IRS then issued affected items notices of deficiency to taxpayer and decedent's estate determining various additions to tax. Taxpayer and the estate filed timely petition for redetermination. The Tax Court (Peter J. Panuthos, Chief Special Trial Judge) held: (1) as to decedent's estate, filing of request for prompt assessment meant deficiency notices were invalid and therefore court lacked jurisdiction; but (2) as to taxpayer, the deficiency notices were valid and the statute of limitations did not bar the computational adjustments or the subsequent determinations of additions to tax. See Callaway v. Commissioner, 75 T.C.M. (CCH) 1956 (1998). Taxpayer and the IRS settled certain issues by agreement, pursuant to which a stipulated decision entered, preserving petitioner's right to appeal the statute of limitations ruling. This appeal followed.

The Court of Appeals (Leval, J.) holds: (1) decedent's distributive share of partnership items were separate property and did not become spouse's property as a consequence of filing a joint tax return; (2) taxpayer owned no interest in partnership items taken into account on joint return; (3) when decedent's partnership items converted into nonpartnership items, all of the partnership items taken into account on joint return necessarily converted into nonpartnership items; (4) statutory notice of deficiency procedures under subchapter B applied to assessment of deficiencies against either taxpayer, see I.R.C. § 6230(a)(2)(A)(ii); (5) statute of limitations on assessments of taxes attributable to converted nonpartnership items expired on December 23, 1992, see I.R.C. §§ 6229(f), 6501(d), (n)(2); Treas. Reg. § 301.6501(d)-1(b); and (6) "precautionary" assessments against taxpayer in 1993, computational adjustments in July, 1996, and the affected items notices of deficiency issued in August 1996, were all invalid.

REVERSED and REMANDED.

FRANK AGOSTINO, Calo Agostino, P.C., Hackensack, N.J., for Appellant.

ROBERT J. BRANMAN (Loretta C. Argrett, Assistant Attorney General and Richard Farber, Attorney, on the brief), Department of Justice, Washington, D.C., for Appellee.

Before: LEVAL, CABRANES and POOLER, Circuit Judges.

JUDGE POOLER concurs, in part, in a separate opinion.

LEVAL, Circuit Judge:

Elizabeth N. Callaway ("the taxpayer" or "Elizabeth") appeals from so much of the March 10, 1998 Opinion and Order and the November 17, 1998 Decision of the United States Tax Court (Peter J. Panuthos, Chief Special Trial Judge) that held that computational adjustments and subsequent affected items notices of deficiency issued to her were valid and were not time-barred. We have jurisdiction pursuant to I.R.C. § 7482(a).

This is a case of first impression in the Courts of Appeals, raising an issue of partnership taxation procedure: A husband held a partnership interest as separate property but filed a joint tax return with his wife thereby taking his distributive share of the partnership's tax items into account in computing the tax owed on the couple's aggregate income. See I.R.C. §§ 702, 6013(a), (d)(3); Treas. Reg. §§ 1.702-1(a), 1.6013-4(b). The husband died, and his estate filed a request for prompt assessment. See I.R.C. § 6501(d). As a result of the request, the husband's share of the partnership's tax items converted from partnership items into nonpartnership items. See I.R.C. § 6231(b)(1)(D), (c)(1); Temp. Treas. Reg. § 301.6231(c)-8T. The question presented is what effect that conversion has on the procedures for assessing deficiencies attributable to those same items against his wife. We conclude that where only the husband owned an interest in his distributive share of partnership items, the conversion of his partnership items into nonpartnership items necessarily converts into nonpartnership items all the items taken into account on the joint return by reason of his interest. They are therefore nonpartnership items with respect to assessments against either spouse. As a consequence: (1) statutory notice of deficiency procedures apply to an assessment of deficiencies attributable to these items against either spouse, see I.R.C. § 6230(a)(2)(A)(ii); and (2) the statute of limitations period will be the greater of one year or such longer period as remains open against either spouse. See I.R.C. § 6229(f).

Applying these conclusions of law to the facts of this case, we conclude the Commissioner had until December 23, 1992 to issue any statutory notice of deficiency to either taxpayer or her deceased spouse's estate. The 1993 "precautionary" assessments, the 1996 computational adjustments and the 1996 affected items notices of deficiency were therefore procedurally invalid and time barred, with respect to both the taxpayer and her deceased spouse's estate.

We therefore reverse the Tax Court's ruling and remand for further proceedings.

BACKGROUND

A. TEFRA's Statutory and Regulatory Framework.

Under the Internal Revenue Code (the "Code") partnerships are not taxable entities. See I.R.C. § 701; Treas. Reg. § 1.701-1.¹ Therefore, unlike individuals and corporations, partnerships do not file tax returns; instead they file information returns. See I.R.C. § 6031; Treas. Reg. § 1.6031-1. While partnerships are not taxed, taxes are imposed on their partners on a pass-through basis. Each partner is individually required to take into account his distributive share of the partnership's tax items in computing his income tax liability. See I.R.C. §§ 701, 702; Treas. Reg. § 1.702-1(a).

Prior to 1982, adjustments to the tax liability of the individual partners based on the operations of the partnership were determined at the individual partners' level. This resulted in duplication of administrative and judicial resources and sometimes in inconsistent results as between partners. See Randell v. United States 64 F.3d 101, 103 (2d Cir. 1995). The Internal Revenue Service was obligated to audit each partner individually to conform the tax treatment of all the partners. To extend the statute of limitations with respect to the partners' liability for the operation of the partnership, the IRS needed to obtain consent for an extension from each of the partners, not the partnership. Similarly, settlement agreements or judicial determinations with regard to one partner were not binding on the other partners. And because the IRS might fail to complete these individual audits and adjustments before the statute of limitations expired with respect to a partner, inconsistent treatment of similarly situated taxpayers could result. See generally H.R. Conf. Rep. No. 97-760, at 599 (1982), reprinted in 1982-2 C.B. 600, 662.

To ameliorate these difficulties, Congress enacted the Tax Treatment of Partnership Items Act of 1982, as Title IV of the Tax Equality and Fiscal Responsibility Act of 1982 ("TEFRA"), Pub. L. No. 97-248, 96 Stat. 324, 648, now codified as amended as subchapter C of Chapter 63 of the Code, at sections 6221 to 6234. The TEFRA provisions establish a single unified procedure for determining the tax treatment of all partnership items at the partnership level, rather than separately at the partner level. See H.R. Conf. Rep. No. 97-760, at 599-600. Under the TEFRA provisions "the tax treatment of any partnership item . . . shall be determined at the partnership level." I.R.C. § 6221. A "partnership item" is a tax item "more appropriately determined at the partnership level than at the partner level." I.R.C. § 6231(a)(3). As prescribed by the Regulations, the term "partnership item" includes "[t]he partnership aggregate and each partner's share of . . . [i]tems of income, gain[,] loss, deduction, or credit of the partnership." Treas. Reg. § 301.6231(a)(3)-1(a)(1)(i). A "nonpartnership item" is one that is "not a partnership item." I.R.C. § 6231(a)(4).

The determination whether an item is a "partnership item" or a "nonpartnership item" is the threshold question for the application of the TEFRA procedures. While partnership items are subject to TEFRA's centralized audit procedures, see I.R.C. §§ 6211(c), 6216(4), 6221, 6230(a)(1), the tax treatment of nonpartnership items is determined at the level of the individual partner's return, pursuant to the notice of deficiency procedures of subchapter B of Chapter 63, sections 6211 to 6216. See I.R.C. §§ 6212(a), 6230(a)(2). The text and structure of the Code, as well as the legislative history of the TEFRA provisions, leave no doubt that Congress intended the procedures of subchapters B and C to have mutually exclusive jurisdiction over nonpartnership and partnership items respectively. See generally Maxwell v. Commissioner, 87 T.C. 783, 788 (1986) (Congress intended existing rules relating to administrative and judicial proceedings, statutes of limitations and settlements to continue to govern determination of tax liability attributable to nonpartnership items); H. R. Conf. Rep. 97-760, at 611 ("Neither the Secretary nor the taxpayer will be permitted to raise nonpartnership items in the course of a partnership proceeding nor may partnership items, except to the extent they become nonpartnership items under the rules, be raised in proceedings relating to nonpartnership items of a partner.").

In certain circumstances a partnership item may be "treated as" a nonpartnership item. See § 6231(a)(4), (b)(1). The effect of such a conversion is therefore to except the item in question from audit proceedings under subchapter...