In re Martinez

• Decision Date: 03 April 2009
• Docket Number: No. 07-31163.,07-31163.
• Citation: 564 F.3d 719
• Parties: In the Matter of: Elvin L. MARTINEZ, Debtor. United States of America, Appellee-Cross-Appellant, v. Elvin L. Martinez, Appellant-Cross-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

564 F.3d 719

In the Matter of: Elvin L. MARTINEZ, Debtor United States of America, Appellee-Cross-Appellant, v. Elvin L. Martinez, Appellant-Cross-Appellee.

No. 07-31163.

United States Court of Appeals, Fifth Circuit.

April 3, 2009.

Francesca Ugolini Tamami (argued), John M. Bilheimer, Michael J. Haungs, U.S. Dept. of Justice, Tax Div., App. Section, Washington, DC, for U.S.

Eric Joseph Derbes, Albert J. Derbes, IV (argued), Melanie Mabile Mulcahy, The Derbes Law Firm, Metairie, LA, for Martinez.

Appeal from the United States District Court for the Eastern District of Louisiana.

Before REAVLEY, BARKSDALE and GARZA, Circuit Judges.

REAVLEY, Circuit Judge:

This appeal presents questions of a limitation bar to income tax adjustments for limited partnerships and the effectiveness of extensions executed by the tax matters partner. Debtor Elvin L. Martinez seeks to avoid tax liabilities associated with various partnerships for the years 1987 through 1993, which he contends were discharged in his personal bankruptcy because the Internal Revenue Service (IRS) failed to assess the taxes within the three-year limitations period for doing so. The issue on appeal is whether the limitations period was tolled by actions of the tax matters partner, Walter J. Hoyt, III. The bankruptcy court determined that for the years 1990 to 1993 Hoyt's challenge to the taxes in the tax court precluded the IRS from assessing any tax until completion of those proceedings, and therefore the later assessments for those years were not filed outside the limitations period, and Martinez's liabilities were not discharged. For the years 1987 to 1989, however, the court determined that Hoyt's consents on behalf of the partnership to extend the limitations period were invalid because Hoyt had a disabling conflict of interest of which the IRS was aware, and therefore Martinez's tax liabilities were discharged in bankruptcy. Martinez and the Government cross appeal from the district court's order affirming the bankruptcy court. We AFFIRM the district court's judgment with respect to the years 1990 to 1993, but we REVERSE with respect to the years 1987 to 1989.

I.

Beginning in the 1970s Walter J. Hoyt, III, formed scores of limited partnerships, ostensibly to engage in the business of breeding cattle and sheep. Although the partnerships owned real livestock, they actually served as abusive tax shelters from which individual tax savings could be achieved through partnership deductions and losses. Hoyt promoted the partnerships to investors around the country, much to his personal gain.

The partnership interests consisted of "units" purchased by investors with cash and promissory notes. The partners also used notes to buy the cattle from Hoyt's family-run cattle operation, which then acted as manager of the herds. The cattle purportedly would produce calves, which could be sold to cover the partnership costs. The herds would also increase in size through the purchase of additional mature cattle. Partnership losses and credits would be passed through to the individual partners to reduce their personal tax liabilities to zero and to obtain tax refunds. The refunds were used to cover the cost of the investors' investment and to make payments on the promissory notes. Hoyt was the general partner and prepared all of the tax returns for both the partnerships and most of the individual partners through his tax preparation firm.

Since 1980, the IRS and other government agencies had been investigating Hoyt's partnerships because of the suspicion that Hoyt routinely overvalued the cattle in order to achieve excessive depreciation, overstated the number of cattle in existence, and commingled the herd among the different partnerships. In 1989 the IRS unsuccessfully challenged Hoyt's partnerships in Bales v. Commissioner,¹ where the tax court held that the partnerships were not shams and that the individual partners were entitled to claim their allowable share of partnership losses. The IRS conducted criminal investigations of Hoyt from April 1984 to August 1987, and from July 1989 to October 1990. In each case the Government decided not to prosecute Hoyt. Hoyt was also investigated from August 1993 to October 1993 and again in September 1995, but each investigation ended without a prosecution. The Government was unable to prevail against Hoyt until 2001, when he was convicted of conspiracy, mail fraud, bankruptcy fraud, and money laundering in connection with partnership activities.

Debtor Martinez became an investor and partner with Hoyt in 1985 and remained involved in four partnerships until 1994. Hoyt was the designated tax matters partner for all of the partnerships and acted accordingly as liaison with the IRS in administrative and litigation proceedings on tax matters concerning the partnerships.² Beginning in 1988, the IRS sent numerous notices to Martinez about its concerns with Hoyt's activities and the claimed deductions and losses on partnerships returns. The notices stated the IRS's belief that purported tax shelter deductions and/or credits were not allowable and that, if claimed, the IRS planned to disallow them. The notices also informed Martinez that the Internal Revenue Code provided for penalties against partners for negligence, overvaluation, and understatement of income on partnership returns, and that if Hoyt claimed the deductions and credits Martinez might wish to seek an adjustment himself. The IRS also sent several notices in 1992 informing Martinez of problems with claimed deductions for passive losses that Hoyt advocated, and it suggested that Martinez might wish to file an amended personal return or consult with an accountant or attorney. Martinez did not respond to the IRS's notices and instead forwarded them to Hoyt.

Generally, when the IRS disagrees with a partnership's claim on a return it has three years in which to audit the return and issue a deficiency notice, known as a Notice of Final Partnership Administrative Adjustment.³ The period for the tax assessment is then extended for one year after the adjustment.⁴ In the instant case, the IRS disagreed with Hoyt's partnership returns for the tax years 1987 to 1989 but was unable to issue timely adjustments. Hoyt, acting as the tax matters partner, granted the IRS extensions of the three-year limitations period, however. The validity of the subsequent adjustments hinges on the validity of the extensions.

The extensions were signed from February 1991 to March 1993. Hoyt granted the first extension of the limitations period for 1987 because an IRS team was already conducting an audit for the years 1980-1986, and he wished to delay the 1987 audit until the earlier examination was complete. In December 1991 the IRS then asked Hoyt to agree to a second extension. It believed that without that extension it would have to close its audit and issue adjustments with blanket disallowances of all claimed deductions, but it wished to avoid that circumstance and wanted to obtain further documentation from Hoyt.

At about the same time that it asked for the extension, the IRS also informed Hoyt that it was considering assessing preparer penalties against him. Hoyt responded that he would grant the extensions to issue the adjustments if the IRS would agree to extend the limitations period for assessing the preparer penalties. The IRS finally agreed as part of a settlement in other litigation involving Hoyt's partnerships occurring in federal court in Oregon, where the IRS was seeking to conduct a physical headcount of the cattle. Hoyt agreed to the extensions and gave the IRS until December 31, 1993, to issue the adjustments for the 1987 to 1989 tax years. The IRS issued them before that deadline.

For the tax years 1990 to 1993, the IRS did not need any extensions and issued timely adjustments disagreeing with Hoyt's partnership returns. Hoyt challenged all of the adjustments from 1987 to 1993 by filing petitions in the tax court contesting them. Those challenges were still being litigated at the time the instant action was filed.

In August 2002 Martinez filed a Chapter 7 bankruptcy petition. The bankruptcy court issued a discharge, and the case was closed. The IRS subsequently sent notices of tax deficiency to Martinez for the years 1987 through 1993 in connection with improperly claimed deductions from his membership in Hoyt's partnerships. Martinez then reopened the bankruptcy case in October 2003 to claim that all of his tax liabilities had been discharged. Martinez's theory was that Hoyt had acted under a disabling conflict of interest when, as tax matters partner, Hoyt granted the IRS extensions of the limitations period for the 1987 to 1989 tax years and when he challenged the IRS's adjustments in the tax court for the 1990 to 1993 tax years. He reasoned that any taxes sought by the IRS were therefore no longer assessable and had been discharged by the bankruptcy proceeding.

After a two-day trial, the bankruptcy court issued a decision separately analyzing the two time periods. First, with respect to 1990 to 1993, the court held that the IRS issued valid adjustments, which Hoyt then challenged by filing timely tax court petitions. Once those petitions were entered on the tax court docket, said the court, the IRS was statutorily precluded from assessing a tax until the conclusion of the tax court proceedings, regardless of any alleged conflict of interest. Because those proceedings were still pending, the court held that the limitations period had been tolled and the tax liabilities for 1990 to 1993 were not discharged.

Second, with respect to 1987 to 1989, the bankruptcy court held that the taxes were no longer assessable and were discharged because when Hoyt had signed the extensions of the limitations period he had a disabling conflict of interest and had breached his fiduciary duty to his partners as the tax matters partner. The court found that internal IRS...