Carroll v. U.S.

• Decision Date: 13 September 2001
• Docket Number: No. CV 98-5740(DRH).,CV 98-5740(DRH).
• Citation: 198 F.Supp.2d 328
• Parties: Daniel L. CARROLL and Ingrid N. Carroll, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Southern District of New York

198 F.Supp.2d 328

Daniel L. CARROLL and Ingrid N. Carroll, Plaintiffs, v. UNITED STATES of America, Defendant.

No. CV 98-5740(DRH).

United States District Court, S.D. New York.

September 13, 2001.

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Ingram Yuzek Gainen Carroll & Bertolotti, LLP, New York City by David G. Ebert, for Plaintiffs.

Eileen J. O'Connor, Assistant Attorney General, Tax Division, United States Department of Justice, Washington, D.C. by John A. Lindquist, for Defendant.

MEMORANDUM OPINION AND ORDER

HURLEY, District Judge.

Pending before the Court in this action for recovery of federal income tax, interest, penalties and additions to tax assessed by the Defendant United States [hereinafter "IRS"] against taxpayer husband and wife Plaintiffs Daniel and Ingrid Carroll is (1) the IRS's motion, made pursuant to Rules 12(b)(1), 12(b)(6), and 56(c) of the Federal Rules of Civil Procedure, for an order dismissing the Complaint for lack of subject matter jurisdiction and failure to state a claim upon which relief may be granted, or alternatively, for summary judgment, (U.S.' Mot. Dismiss Alt. Summ. J.); (2) the Plaintiffs' cross-motion, made pursuant to Rule 15(d), to file a supplemental complaint, (Pls.' Notice Cross-Mot.); and (3) the IRS's motion, made pursuant to Local Civil Rule 6.3, for reconsideration of this Court's Memorandum and Order, dated October 23, 2000, see Carroll v. United States, No. CV 98-5740, 2000 WL 1819419 (E.D.N.Y. Oct.23, 2000) [hereinafter "Carroll II"], that had (a) granted Plaintiffs' motion, made pursuant to Federal Rule of Civil Procedure 56(a), for partial summary judgment with respect to their claim for refund of certain penalties assessed against them by the IRS, and (b) granted Plaintiffs' motion, made pursuant to Local Civil Rule 6.3, for reconsideration of this Court's Memorandum and Order, dated October 19, 1999, see Carroll v. United States, No. CV 98-5740, 1999 WL 1090814 (E.D.N.Y. Oct.19, 1999) [hereinafter "Carroll I"], that had originally denied Plaintiffs' Rule 56(a) motion. (U.S.' Notice Mot. Recons.)

I. BACKGROUND

The legal framework underlying the instant motions is complex, involving the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"), Pub.L. No. 97-248, 96 Stat. 324 (1982). The factual history in this case—involving 1995 tax assessments related to Plaintiffs' 1982 tax liabilities arising from an investment in a plastics recycling limited partnership, after proceedings in both the United States District Court for the Middle District of Florida and the United States Tax Court—is likewise complex. Therefore the Court sets forth in some detail the legal and factual background precipitating this litigation.

A. TEFRA'S STATUTORY FRAMEWORK

Prior to the enactment of TEFRA, partnerships generally were not taxable entities under the Internal Revenue Code. See Chimblo v. Commissioner, 177 F.3d 119, 121 (2d Cir.1999). Typically, the income and expenses of the partnership would "flow through" to the partners and be taxed at the individual partner level. See Transpac Drilling Venture v. Commissioner, 147 F.3d 221, 223 (2d Cir.1998). However, that statutory setup "proved inefficient and often led to inconsistent results" as between different partners who could separately challenge the taxation of their partnership income, sometimes with different results. See Monti v. United States, 223 F.3d 76, 78 (2d Cir.2000) [hereinafter Monti II]. Congress enacted TEFRA in 1982 to "ensure equal treatment of partners by uniformly adjusting partners' tax liabilities and channeling any challenges ... into a single, unified proceeding." Kaplan v. United States, 133 F.3d 469, 471 (7th Cir.1998) [hereinafter Kaplan II]; accord Chimblo, 177 F.3d at 121.

In order to achieve consistent treatment of partners, TEFRA provides that the tax treatment of "partnership items" is to be determined at the partnership level. 26 U.S.C. § 6221. TEFRA defines a "partnership item" as "any item required to be taken into account for the partnership's taxable year ... to the extent regulations prescribed by the [IRS] provide that ... such item is more appropriately determined at the partnership level than at the partner level." Id. § 6231(a)(3). A "nonpartnership item" is defined in the negative as an item "which is (or is treated as) not a partnership item." Id. § 6231(a)(4). An "affected item" is "any item to the extent such item is affected by a partnership item." Id. § 6231(a)(5). Therefore an affected item is a hybrid in the sense that its proper assessment may require a determination at the individual partner level after the completion of the partnership level proceeding.

TEFRA requires partnerships to designate a "tax matters partner" (TMP) to serve as a liaison between the IRS and the individual partners in administrative proceedings, and as a representative of the partners in judicial proceedings. See id. § 6231(a)(7); Addington v. Commissioner, 205 F.3d 54, 60 (2d Cir.2000). The TMP is a fiduciary with the authority to represent and, under certain circumstances, bind the limited partners in such proceedings. Transpac Drilling, 147 F.3d at 223. The individual limited partners may designate any general partner to be the partnership's TMP. 26 U.S.C. § 6231(a)(7)(A). Absent such designation, the "general partner having the largest profits interest in the partnership at the close of the taxable year involved" is the TMP by default, id. § 6231(a)(7)(B), unless that procedure is impracticable, in which case the IRS may select some other partner to serve as TMP. Id. § 6231(a)(7).

After a partnership files its return for a tax year, the IRS may decide to commence an administrative proceeding in order to make adjustments to the return. The IRS has three years from the date the partnership return is due to issue a final partnership administrative adjustment ("FPAA") affecting liability for taxes attributable to "partnership items." See id. § 6229(a). However, this three year statute of limitations may be extended by agreement between the IRS and the partnership's TMP, whose consent binds all partners. Id. § 6229(b)(1)(B).

The IRS must notify partners of any adjustments it makes to partnership and nonpartnership items. Notice is given through an FPAA for adjustments to partnership items, see id. § 6223(a)(2), and through a "notice of deficiency" for nonpartnership items, see id. §§ 6211, 6212. See also PAA Mgmt., Ltd. v. United States, 962 F.2d 212, 214-15 (2d Cir.1992). To ease the burden of notifying partners in partnerships exceeding 100 members, TEFRA only requires that the FPAA be sent to "notice partners" (i.e., those who own at least one percent of the partnership) within 60 days after the IRS mails the FPAA to the TMP. See 26 U.S.C. §§ 6223(a)(2), (b)(1), (d)(2), 6231(a)(8). Thus, the IRS is not required to individually notify small-share partners (i.e., "non-notice partners") of adjustments to partnership items; notice to the TMP is deemed constructive notice upon them. Kaplan II, 133 F.3d at 472. Rather, it is the responsibility of the TMP to forward a copy of the FPAA to non-notice partners. See id. § 6223(g). If the TMP fails to notify non-notice partners of adjustments to partnership items, it does not affect the applicability of any adjustments or partnership proceedings. See id. § 6230(f).

For 90 days after the mailing date of the FPAA, the TMP has the exclusive right to file an action for readjustment of the partnership items in either Tax Court, the Court of Federal Claims, or a United States District Court. Id. § 6226(a). If the TMP fails to bring an action to contest the FPAA within that time period, any notice partner, or any group of non-notice partners holding at least a 5% interest in the aggregate, may file suit within the following 60 days in any one of those courts. Id. § 6226(b)(1). Once a petition challenging an FPAA is filed, all partners are considered parties to the action and will be bound by the decision regardless of whether they elected to participate. Id. § 6226(c); Monti II, 223 F.3d at 79. This process prevents subsequent, multiple suits by individual partners.

Once a court's decision in an action for readjustment of partnership items becomes final, it is conclusive with regard to the treatment of partnership items. 26 U.S.C. § 6230(c)(4). If the IRS decides to assess taxes upon the individual partners as a result of the outcome of such a proceeding, it must do so within a year from the date the decision becomes final, id. § 6229(d), by sending a notice of deficiency to each individual partner-taxpayer within that time. See id. § 6212(a).

B. JURISDICTION OF FEDERAL DISTRICT COURTS OVER ACTIONS FOR RECOVERY OF TAXES WRONGFULLY ASSESSED OR COLLECTED

Pursuant to 28 U.S.C. § 1346(a)(1), federal district courts enjoy original jurisdiction over

[a]ny civil action against the United States for the recovery of any internal-revenue tax alleged to have been erroneously or illegally assessed or collected, or any penalty claimed to have been collected without authority or any sum alleged to have been excessive or in any manner wrongfully collected under the internal-revenue laws.

However, that broad grant of jurisdiction is tempered by certain procedural requirements, and by special rules applicable to "partnership items" under TEFRA.

Procedurally, 26 U.S.C. § 7422(a) provides that no such suit shall be maintained "until a claim for refund or credit has been duly filed" with the IRS. The taxpayer must file his claim for refund with the IRS within two years (according to the administrative limitation period applicable under the facts of this case) from the date he paid the tax that he seeks to recover. Id. § 6511(a). Once a claim for refund has been filed, the taxpayer must still wait six months before bringing suit, unless the IRS sooner renders an adverse decision on the claim. Id. § 6532(a)(1). An adverse decision on the claim triggers a...